What is the Probability-Weighted Expected Return Method (PWERM)?

The most thorough method of allocating enterprise value to a stake in a company is the Probability-Weighted Expected Return Method (PWERM). It is also significantly more complicated to implement than the other methods available. PWERM requires an analyst to model the distribution of enterprise value in a number of different exit scenarios, determine the likelihood of each scenario, and then calculate the value of the stake today in the context of these factors.

To apply PWERM to a stake, the analyst must first consider the various exit scenarios that are possible. Depending on their methodology, they may model either a single instance of each type of exit, such as a sale at a specific future date and valuation, or a variety of possibilities for each type of exit, representing a range of valuations and dates. In each scenario, they will distribute the value to the company’s debt and equity-holders, determining an expected return for each (including the stakeholder on whose behalf they are performing the valuation). Then, the analyst will determine the probability of each of these exits and multiply the probability by the stakeholder’s expected return. 

Added together, these probability-weighted expected returns allow the analyst to estimate the current value of the stakeholder’s shares in the context of their likely value at exit. Of the various methods to allocating enterprise value available to an ASC 820 analyst, this method is the most rigorous in its consideration of factors in exit scenarios, but because it relies on a large number of assumptions, it’s often considered more applicable for later-stage companies than for very early-stage companies.

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