> ## Documentation Index
> Fetch the complete documentation index at: https://valuation-101.com/docs/llms.txt
> Use this file to discover all available pages before exploring further.

# Failure Rate

> Estimate the probability of corporate failure using bond ratings or company age.

## Module: `lib/failure_rate.py`

Estimates the cumulative probability that a company fails (defaults) over the 10-year projection period. This probability is used to adjust the final DCF value downward.

## How it's applied

$\text{Adjusted value} = \text{DCF value} \times (1 - \text{failure probability}) + \text{distress proceeds} \times \text{failure probability}$

Distress proceeds are typically estimated as a percentage of book value (default: 50% of book assets, though this varies by industry).

## Key functions

### `failure_rate_by_rating(rating, horizon=10)`

Uses historical cumulative default rates from Moody's and S\&P, indexed by credit rating.

**Parameters:**

* `rating` — synthetic or actual credit rating (e.g., "BBB", "B+", "CCC")
* `horizon` — years over which to measure default probability (default: 10)

**Returns:** Cumulative default probability as a decimal.

### `failure_rate_by_age(company_age, sector)`

Uses Bureau of Labor Statistics business survival data, indexed by company age and sector.

**Parameters:**

* `company_age` — years since founding or incorporation
* `sector` — broad industry sector

**Returns:** Estimated failure probability over 10 years.

## Which method to use

| Situation                                                           | Recommended method                                          |
| ------------------------------------------------------------------- | ----------------------------------------------------------- |
| Company has a credit rating or sufficient data for synthetic rating | `failure_rate_by_rating`                                    |
| Company is young, unrated, or pre-revenue                           | `failure_rate_by_age`                                       |
| Company is a large, stable, investment-grade firm                   | Failure probability is typically near zero — can be skipped |

## Data sources

* `rating_default_probabilities.json` — Moody's/S\&P historical cumulative defaults by rating over 1–10 year horizons
* `bls_survival_rates.json` — US Bureau of Labor Statistics corporate failure rates by sector and age (5-year, 10-year)