Cost of Capital in Litigation. Applications and Examples. 4th Edition

  • ID: 2211452
  • Book
  • 302 Pages
  • John Wiley and Sons Ltd
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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

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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

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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.

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