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Courts have long recognized the discounted cash flow (DCF) methodology as an important tool for valuing firms and assessing solvency. Some courts have gone so far as to call the DCF the "preeminent valuation methodology."1 Many introductory finance texts also emphasize the DCF when discussing the valuation of firms, projects or financial instruments-even to the exclusion of other methodologies.2 While the DCF is an important model, it is not the only method available to determine value and solvency. Like all valuation models, the DCF is dependent on the quality of its inputs. These inputs typically include a projection of future cash flows (produced by management and/or a valuation expert) for a finite period that usually covers at least five years, a steady state growth rate at which cash flows are expected to grow in perpetuity beyond the end of the explicit projection period, and a discount rate by which the future cash flows are reduced to derive the present value of the enterprise.
Particularly when performing retrospective valuation analyses of a company in bankruptcy, the very traits that make the DCF methodology so powerful-the fact that it is a companyspecific and forward-looking assessment of value-may potentially compromise its effectiveness. For example, a valuation practitioner may need to begin a DCF analysis using management projections that were prepared months or years before by management and support personnel who are no longer with the company (and consequently unavailable to aid in verfiying assumptions and computations in those projections). In some cases, these individuals may even be defendants in ongoing preference, fraudulent conveyance, accounting fraud or other legal actions, which may accompany a bankruptcy filing. If the valuation professional elects to create new projections, it adds more levels of complexity and judgment to the analysis, and may leave the valuation practitioner open to charges of subjectivity, bias and "Monday morning quarterbacking" from opposing experts. Determining an appropriate discount rate and terminalgrowth rate for a DCF model, while typically less complex than forecasting financial results, also requires numerous judgments and, thus, may also leave the valuation practitioner open to criticisms of bias and hindsight.
We make these points not to diminish the importance of the DCF methodology, but to argue for the inclusion, whenever relevant and possible, of...