Illiquid assets are often sold at a discount compared to comparable liquid assets when estimating value using multiples of revenues or cash flows or earnings. Studies show a 35% discount for illiquid assets (Maher 1976). How can you compute the liquidity discount- the penalty for not being a liquid asset?
There are two approaches to arrive at the liquidity discount.
Adjusted Discount Rates: One way to incorporate a liquidity discount is to have higher discount rates. The challenge will be to figure how the increase in the discount rate for illiquid assets. Silber (1991) regressed various factors against price discounts in restricted stock. A similar method can be taken with a dummy variable indicating illiquid assets in addition to other variables such as revenues, cash flows, earnings, profitability, etc.
Bid-Ask spread: Another method to quantify the liquidity discount is to evaluate the bid-ask spread of similar assets. The bid-ask spread is indicative of liquidity. Highly traded assets have lower bid-ask spread when compared to poorly traded assets.