The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, Second Edition

3. Probabilistic Valuation: Scenario Analysis, Decision Trees, and Simulations

The preceding chapter examined ways in which we can adjust the value of a business for its risk. Notwithstanding their popularity, all the approaches we described share a common theme. The riskiness of an asset or business is encapsulated in one number—a higher discount rate, or lower cash flows. This computation almost always requires us to make assumptions (often unrealistic) about the nature of risk.

This chapter considers a different and potentially more informative way of assessing and presenting the risk in an investment. Rather than compute an expected value for an asset or firm that tries to capture the expected value across different possible outcomes, we ...