Synopses & Reviews
Praise for Cost of Capital in Litigation: Applications and Examples"After revising their existing text, Cost of Capital: Applications and Examples, the authors have endeavored to expand their treatment of the subject and further explore the role of cost of capital in the courts. Addressing various methods for calculating value and different standards of value, the authors explain how courts may differ in their decisions based on the topic, jurisdiction, or available evidence. This new compilation is an important contribution to the field of valuation and will serve as an imminently helpful resource for attorneys and judges. Shannon Pratt and Roger Grabowski have provided yet another thoughtful, helpful, and excellent resource for all practitioners interested in how appraisers and courts have, and should, arrive at value."?
—From the Foreword by David Laro, Judge, United States Tax Court
"Cost of Capital in Litigation is a very helpful resource for litigators faced with valuation disputes involving an assessment of discounted cash flows. In the area with which I am most familiar—Delaware valuation law—it is thorough and insightful. More important to me, its introductory material nicely lays out the conceptual structure of the valuation issue, and the remaining chapters gather lots of information about the treatment of the issue in areas with which I am less familiar, (such as bankruptcy law and domestic property litigation)."
—Lawrence A. Hamermesh, Ruby R. Vale Professor of Corporate and Business Law, Widener University School of Law, Wilmington, Delaware
"Cost of Capital in Litigation comprehensively deals with a difficult subject, pointing out common grounds as well as differences among experts in the treatment of this subject. It is a must first stop for the uninitiated in the subject and the ultimate checklist that every practitioner should consult. Particularly useful are the chapters focusing with the eyes of experts on the treatment of cost of capital in specific areas of litigation. Notably, the authors alert the reader to those aspects of the various methods for determining cost of capital that may differentiate among the suitability of the methods based on available data, the circumstances presented, and the legal issue under consideration."
—Reeves Westbrook, Esq., Partner and Chair of the Tax Group, Covington & Burling LLP
"Shannon Pratt and Roger Grabowski have consolidated information on important theoretical valuation frameworks, practical applications, and case law needed by finance professionals, attorneys, and judges in these challenging times. Cost of Capital in Litigation serves as a solid well-written reference on cost of capital and valuation that I recommend to both practitioners and students."
—Theodore Barnhill, Professor of Finance and Director of the Global and Entrepreneurial Finance Research Institute, The George Washington University
"Valuation in litigation settings requires careful analysis, solid evidence, and defensible positions. Cost of Capital in Litigation details the nuances and subtle but critical elements of crafting a defens-ible position for experts, attorneys, and others who need to understand how and why valuation cases are won and lost."
—Hal Heaton, Professor of Finance, Marriott School of Management, Brigham Young University
"Discount rates are often crucial components in calculating damages. Even small changes in these numbers can have large effects on the amounts in dispute—and the magnitude of damages won or lost. Cost of Capital in Litigation explains the underlying economic theory. It then offers separate chapters elaborating on rate of return approaches in their widely varied forensic contexts. This helpful compendium even includes an outline of cost of capital questions for use by attorneys and their financial experts. No business litigator should be without it."
—Peter V. Baugher, Esq., Partner, Schopf & Weiss LLP
Synopsis
Cost of Capital in Litigation addresses cost of capital issues in litigation and discusses major decisions, highlighting how to avoid errors that have often been made by experts. The book helps the attorney and valuation expert understand the decisions within the context of the theory of cost of capital and includes a chapter on cross-examining experts on cost of capital issues. Throughout, there are citation to relevant material and cross-reference to Cost of Capital: Applications and Examples, Fourth Edition.
Synopsis
Cost of Capital in Litigation: Applications and ExamplesThe "cost of capital" is the expected rate of return for the purpose of attracting funds, and its estimation has long been recognized as one of the most critical elements in business valuation and damages calculations. Addressing the many different methods of calculating value and different standards of value, Cost of Capital in Litigation delves deeply into the myriad reasons why and how courts may differ in their decisions based on the topic, jurisdiction, or available evidence.
Because cost of capital is critical to the valuation of any ongoing business, the thorough understanding, analysis, and presentation of cost of capital issues goes a long way toward winning in court. Navigating deftly between fundamentals and intricate nuances, Cost of Capital in Litigation addresses the needs of those in the valuation profession who require both introductory materials and detailed analysis. Shannon Pratt and Roger Grabowski—two major figures in the world of business valuation—draw on their decades of experience in business valuations and as expert witnesses to highlight major decisions as well as errors to avoid.
A valuable resource for attorneys and valuation experts, Cost of Capital in Litigation includes:
A useful summary of investment and valuation fundamentals, including explanations of economic theories and valuation models
The cost of capital and discount rates in various court cases, including estate and gift tax cases, intellectual property disputes, bankruptcies, and family law cases
Exceptionally detailed reviews of the methodology propounded by experts, and those accepted or rejected by courts, along with commentary on the experts' and courts' reasoning and analysis
Summaries of existing court decisions, plus discussion of flaws in reasoning, methodology, and analysis that should be considered in the future by litigants, experts, attorneys, and judges
A summary of how the Delaware Court of Chancery and the Delaware Supreme Court have viewed the discounted cash flow method
Summaries of cost of capital guidelines used by state assessment authorities in unitary assessment matters
Comprehensive discussion of cost of capital methods used in regulated industries for rate making
Complemented by a foreword by David Laro, Judge of the United States Tax Court, Cost of Capital in Litigation will help professionals in the legal, financial and accounting fields develop a thorough understanding of court decisions within the context of the theory of cost of capital.
The "father of business valuations," SHANNON P. PRATT is the author of several bestselling Wiley business valuation publications and also a sought-after speaker at business valuation industry conferences. He is the managing owner of Shannon Pratt Valuations, Portland, Oregon. He has served as supervisory analyst for over 3,000 business valuation engagements in forty years and as an expert witness in numerous state and federal courts on contested business valuations.
Synopsis
Praise for Cost of Capital in Litigation: Applications and Examples"After revising their existing text, Cost of Capital: Applications and Examples, the authors have endeavored to expand their treatment of the subject and further explore the role of cost of capital in the courts. Addressing various methods for calculating value and different standards of value, the authors explain how courts may differ in their decisions based on the topic, jurisdiction, or available evidence. This new compilation is an important contribution to the field of valuation and will serve as an imminently helpful resource for attorneys and judges. Shannon Pratt and Roger Grabowski have provided yet another thoughtful, helpful, and excellent resource for all practitioners interested in how appraisers and courts have, and should, arrive at value."?
—From the Foreword by David Laro, Judge, United States Tax Court
"Cost of Capital in Litigation is a very helpful resource for litigators faced with valuation disputes involving an assessment of discounted cash flows. In the area with which I am most familiar—Delaware valuation law—it is thorough and insightful. More important to me, its introductory material nicely lays out the conceptual structure of the valuation issue, and the remaining chapters gather lots of information about the treatment of the issue in areas with which I am less familiar, (such as bankruptcy law and domestic property litigation)."
—Lawrence A. Hamermesh, Ruby R. Vale Professor of Corporate and Business Law, Widener University School of Law, Wilmington, Delaware
"Cost of Capital in Litigation comprehensively deals with a difficult subject, pointing out common grounds as well as differences among experts in the treatment of this subject. It is a must first stop for the uninitiated in the subject and the ultimate checklist that every practitioner should consult. Particularly useful are the chapters focusing with the eyes of experts on the treatment of cost of capital in specific areas of litigation. Notably, the authors alert the reader to those aspects of the various methods for determining cost of capital that may differentiate among the suitability of the methods based on available data, the circumstances presented, and the legal issue under consideration."
—Reeves Westbrook, Esq., Partner and Chair of the Tax Group, Covington & Burling LLP
"Shannon Pratt and Roger Grabowski have consolidated information on important theoretical valuation frameworks, practical applications, and case law needed by finance professionals, attorneys, and judges in these challenging times. Cost of Capital in Litigation serves as a solid well-written reference on cost of capital and valuation that I recommend to both practitioners and students."
—Theodore Barnhill, Professor of Finance and Director of the Global and Entrepreneurial Finance Research Institute, The George Washington University
"Valuation in litigation settings requires careful analysis, solid evidence, and defensible positions. Cost of Capital in Litigation details the nuances and subtle but critical elements of crafting a defens-ible position for experts, attorneys, and others who need to understand how and why valuation cases are won and lost."
—Hal Heaton, Professor of Finance, Marriott School of Management, Brigham Young University
"Discount rates are often crucial components in calculating damages. Even small changes in these numbers can have large effects on the amounts in dispute—and the magnitude of damages won or lost. Cost of Capital in Litigation explains the underlying economic theory. It then offers separate chapters elaborating on rate of return approaches in their widely varied forensic contexts. This helpful compendium even includes an outline of cost of capital questions for use by attorneys and their financial experts. No business litigator should be without it."
—Peter V. Baugher, Esq., Partner, Schopf & Weiss LLP
Synopsis
Cost of Capital in Litigation: Applications and ExamplesThe "cost of capital" is the expected rate of return for the purpose of attracting funds, and its estimation has long been recognized as one of the most critical elements in business valuation and damages calculations. Addressing the many different methods of calculating value and different standards of value, Cost of Capital in Litigation delves deeply into the myriad reasons why and how courts may differ in their decisions based on the topic, jurisdiction, or available evidence.
Because cost of capital is critical to the valuation of any ongoing business, the thorough understanding, analysis, and presentation of cost of capital issues goes a long way toward winning in court. Navigating deftly between fundamentals and intricate nuances, Cost of Capital in Litigation addresses the needs of those in the valuation profession who require both introductory materials and detailed analysis. Shannon Pratt and Roger Grabowski—two major figures in the world of business valuation—draw on their decades of experience in business valuations and as expert witnesses to highlight major decisions as well as errors to avoid.
A valuable resource for attorneys and valuation experts, Cost of Capital in Litigation includes:
A useful summary of investment and valuation fundamentals, including explanations of economic theories and valuation models
The cost of capital and discount rates in various court cases, including estate and gift tax cases, intellectual property disputes, bankruptcies, and family law cases
Exceptionally detailed reviews of the methodology propounded by experts, and those accepted or rejected by courts, along with commentary on the experts' and courts' reasoning and analysis
Summaries of existing court decisions, plus discussion of flaws in reasoning, methodology, and analysis that should be considered in the future by litigants, experts, attorneys, and judges
A summary of how the Delaware Court of Chancery and the Delaware Supreme Court have viewed the discounted cash flow method
Summaries of cost of capital guidelines used by state assessment authorities in unitary assessment matters
Comprehensive discussion of cost of capital methods used in regulated industries for rate making
Complemented by a foreword by David Laro, Judge of the United States Tax Court, Cost of Capital in Litigation will help professionals in the legal, financial and accounting fields develop a thorough understanding of court decisions within the context of the theory of cost of capital.
The "father of business valuations," SHANNON P. PRATT is the author of several bestselling Wiley business valuation publications and also a sought-after speaker at business valuation industry conferences. He is the managing owner of Shannon Pratt Valuations, Portland, Oregon. He has served as supervisory analyst for over 3,000 business valuation engagements in forty years and as an expert witness in numerous state and federal courts on contested business valuations.
Synopsis
Cost of Capital in Litigation addresses cost of capital issues in litigation and discusses major decisions, highlighting how to avoid errors that have often been made by experts. The book helps the attorney and valuation expert understand the decisions within the context of the theory of cost of capital and includes a chapter on cross-examining experts on cost of capital issues. Throughout, there are citation to relevant material and cross-reference to Cost of Capital: Applications and Examples, Fourth Edition.
About the Author
Roger J. Grabowski is Manag-ing Director of Duff & Phelps LLC in Chicago, Illinois, and author of the annual Duff & Phelps Risk Premium Report. He is the co-author of Cost of Capital, Third Edition, and has authored several articles during the crisis that began in 2008, including "Cost of Capital Estimation in the Current Distressed Environment," featured in the Journal of Applied Research in Accounting and Finance. Grabowski has testified in court as an expert witness on many valuation issues.
Table of Contents
About the Authors xi
Foreword xix
Preface xxi
Acknowledgments xxv
Notation System and Abbreviations Used in This Book xxvii
CHAPTER 1: Cost of Capital Basics 1
Introduction 1
Components of a Capital Structure 2
Characteristics of Cost of Capital 3
Cost of Capital Equals the Discount Rate 4
Net Cash Flow 6
Discount Rate Is Not the Same as Capitalization Rate 12
Cost of Capital Should Reflect Risk of the Investment 19
CHAPTER 2: Estimating the Cost of Equity Capital and the Overall Cost of Capital 25
Introduction 25
Estimating the Cost of Equity Capital by the Build-up Method 26
Estimating the Cost of Equity Capital by the Capital Asset Pricing Model 32
Other Methods for Estimating the Cost of Equity Capital 41
Overall (Weighted Average) Cost of Capital 45
CHAPTER 3: Other Cost of Capital Considerations 54
Introduction 54
Standard of Value 55
Handling Discounts for Lack of Marketability 55
How the Cost of Capital Relates to the Excess Earnings
Method of Valuation 58
Adjusting the Discount Rate to Alternative Economic Income Measures 63
Converting from After-Tax Rates to Pretax Rates 64
CHAPTER 4: Cost of Capital in Estate and Gift Tax Matters 67
Introduction 67
Acceptance and Rejection of DCF 67
Evaluation of Cash Flow Forecasts 70
Equity Rate versus WACC 70
Build-up, CAPM, or Something Else? 71
Cost of Equity 71
Consistency of Data 73
Courts Demand Supporting Detail 74
Cost of Capital for a Regulated Company 76
S Corporations 76
Summary 77
CHAPTER 5: Cost of Capital Considerations in Corporate Restructuring and Other Federal Tax Matters 79
Introduction 80
Legal Entity Valuations 81
Intercompany Debt 93
Worthless Stock 95
Transfer Pricing Disputes 96
Summary 100
CHAPTER 6: Cost of Capital Included in Damage Calculations 101
Introduction 101
Why Discounting Is Necessary 101
Is a Risk-free Discount Rate Appropriate? 103
Cost of Capital Is the Appropriate Risk-Adjusted Discount Rate 109
Tax Effects 114
Common Errors in Discounting Lost Profits 114
Exclusion of Expert Testimony 117
Summary 119
CHAPTER 7: Cost of Capital in Intellectual Property Disputes 120
Introduction 121
Categories of Intellectual Property Disputes 122
Cost of Capital Issues in Intellectual Property Disputes 129
Court Guidance Regarding Discount Rate Selection 131
Other Considerations 135
Summary 139
CHAPTER 8: Cost of Capital in Bankruptcy 141
Introduction 141
Cost of Capital for Debt: Cram Down Interest Rates 142
Cost of Capital for Assets 147
Cost of Capital for a Business Enterprise 152
Summary 159
CHAPTER 9: Cost of Capital in Appraisal and Fairness Cases 161
Introduction 161
Discounted Cash Flow in Delaware Law 162
Capital Asset Pricing Model 163
Components of Weighted Average Cost of Capital 164
Build-up Method 181
Additional Points 182
Role of the Expert 182
Summary 184
CHAPTER 10: Cost of Capital in Family Law Matters 185
Introduction 185
Cost of Equity Capital versus WACC 186
Capital Structure: Industry versus Business 193
Solving for Market Value Weight Proportions
and the Cost of Equity Capital 197
The Hidden Impact of Rounding 197
Cost of Capital in Family Law Courts 199
Summary 202
CHAPTER 11: Cost of Capital in Ad Valorem Taxation 203
Introduction 204
Unitary Property Cost of Capital by State 206
Company Cost of Capital versus Asset Cost of Capital 209
Assessed Value versus Market Value 214
General Categories of Legislative Constraints That
Necessitate Adjustments to the Cost of Capital 216
Capital Structure 219
Weighted Average Cost of Capital 220
Ad Valorem Tax Adder 228
Flotation Costs 229
WACC versus WARA 230
Cost of Capital in the Courts 232
Summary 232
CHAPTER 12: Cost of Capital in Regulated Industries 233
Introduction 234
Overview of Regulatory Decision-making Process 234
Role for Cost of Capital 236
Alternative Approaches to Setting Cost of Capital 238
Specific Issues by Technique 251
Other Methods Being Developed 257
Railroad Cost of Capital Issues 258
Summary 262
CHAPTER 13: Questions to Ask Business Valuation Experts 264
Introduction 264
Examination Outline 264
Appendix I Bibliography 273
Appendix II International Glossary of Business Valuation Terms 277
Index 285