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Valuation of Cash Flows with Time-Varying Cessation Risk

Author

Listed:
  • Saha Atanu

    (Compass Lexecon)

  • Malkiel Burton G.

    (Princeton University)

Abstract

We extend the analytical framework of traditional DCF models to allow for the possibility of a time-varying cessation risk for cash flows. We first set out a parsimonious functional form for time-dependent survival probability of cash flows and then derive a closed-form solution for cessation risk-adjusted discount rates within a DCF model. Application of the model to a new data set, created for this paper, demonstrates that U.S. start-up firms face considerable risk of cessation, particularly during the first five years of their existence. This finding suggests that the time-varying discount rates that are appropriate to value them are considerably higher than those used in traditional DCF models.

Suggested Citation

  • Saha Atanu & Malkiel Burton G., 2012. "Valuation of Cash Flows with Time-Varying Cessation Risk," Journal of Business Valuation and Economic Loss Analysis, De Gruyter, vol. 7(1), pages 1-22, May.
    • Handle: RePEc:bpj:jbvela:v:7:y:2012:i:1:n:3
    DOI: 10.1515/1932-9156.1126
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    Cited by:

    1. Kenth Skogsvik & Stina Skogsvik & Henrik Andersson, 2023. "Bankruptcy Risk in Discounted Cash Flow Equity Valuation," JRFM, MDPI, vol. 16(11), pages 1-18, November.
    2. Dietmar Ernst & Werner Gleißner, 2022. "Paradigm Shift in Finance: The Transformation of the Theory from Perfect to Imperfect Capital Markets Using the Example of Company Valuation," JRFM, MDPI, vol. 15(9), pages 1-13, September.
    3. Sujata Behera, 2020. "Does the EVA valuation model explain the market value of equity better under changing required return than constant required return?," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 6(1), pages 1-23, December.

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