February 16, 2011 | Issue #101-3 Forward to a Friend

Consult Damodaran when building WACCs for international companies

Jesse Mucciarone (Cliffs Natural Resources) recently posted a question in LinkedIn’s Valuation group that received some useful responses: “In building a WACC for an international company, what would be the correct inputs? The subject Company is based in Europe, the deal will be financed in U.S. dollars.”

Anton Lezhja (Deloitte Albania) responded:  

“As an appraiser working in Central and Eastern Europe I would draw your attention in several aspects you need to address when building WACC.
1) Risk free rate: Depending on which country in Europe the company is, you may have Rf rate of the country (in case there are long term government bonds of that country, either in local currency or in EUR, or USD) or of another country (usually 20yrs German bonds, but US bonds can also be used).
2) Currency: more important than the transaction currency it is the currency in which the cash flows are generated.
3) Country risk: Damodaran is a good source for the country risk unless you want to build it yourself.
4) ERP: Damodaran and SBBI are good sources for it. Damodaran updates in his website the ERP every month.”

Mark Krickovich (MK Appraisal) and Rod Burkert (Burkert Valuation Advisors, LLC) also suggest consulting Damodaran. “IMO, I think the cost of capital should be built up in terms of either (1) the investors' required rate of return based on the home country of the investors ... with specific weight given to the investment's riskiness or (2) the investment's required rate of return in its home country ... with specific weight given to the currency risk of the investors,” Burkert adds.

Added note:  BVR has signed an exclusive agreement with Business Monitor International, the London-based country and industry risk analysis organization, to offer their proprietary research in the United States.  Look for their reports very soon on www.bvresources.com.

Avoid standard healthcare benchmarks if you get an imaging center engagement

“Valuing a diagnostic imaging center is very different from valuing any other healthcare enterprise,” Douglas Smith (Barrington Lake Group LLC) told listeners yesterday during the BVR webinar Imaging Centers: Lessons from an Industry Expert.  The diagnostic imaging center industry is “changing like crazy,” says Smith, and the centers’ unique structures require intense analysis.

Listed below are some of the potential landmines and valuation considerations “you want to avoid like the plague:”

  • Reimbursement for the technical component, on a per-unit- of-service basis, can either indicate substantial value, or certain impending financial death for the entity being valued.
  • Historic volume projections will, by definition, be based upon the facts of recent history – BUT – the emerging landscape will have an even bigger impact that historical performance.
  • If a particular geographic area population is flat or declining, does the natural increase in a certain imaging modality per population fit the forecast? One also needs to test the service area declared by the entity.
  • Both consultant and appraiser are often challenged on the forecast revenue per unit of service per modality – especially for entities with heavy CT and MRI content.
  • Are there more specialist physician high users of imaging services coming into the area?

Access the complete training pack and Smith’s expertise on valuing imaging centers here.

Federal case pits BV expert vs. MAI on restaurant discount rate

Not many published court opinions give meaningful guidance on determining the discount rate in economic damages case (see BVWire #92-5). A new decision concerning lost profits for the breach of a franchise lease finds the plaintiff’s BV analyst going against a real estate appraiser, with the win going to—wait for it . . . the one that used better industry data and research.

The plaintiff’s expert actually prepared two reports. The first relied on the mitigating rental income from a substitute tenant on the same premises. Because this represented the “best case” stream of income without accounting for vacancies, he used a discount rate of 4.5%, based on the risk-free rate. After the substitute tenant defaulted, however, and given the unstable market, the BV expert revised his rate, beginning with the risk-free rate (4.8% on 20-year U.S. Treasury securities as of Feb. 2010). He also considered the 10.4% used by the plaintiff’s real estate appraiser, and settled on a figure halfway between the two, for a final discount rate of 7.5%.

The defendants’ MAI-certified appraiser criticized the approach. Blending or averaging the risk-free rate with the cap rate was not appropriate, he said. Moreover, the risk-free rate does not accurately reflect the risk associated with a real estate investment. Instead, the MAI expert relied on industry reports and transaction data, which showed average cap rates of 8.5% and average discount rates ranging from 9.58% and 10.10%, with an average spread between the two of about 1.3%. Based this data, the defendants’ expert believed that buyers of restaurant properties would discount franchisee cash flows by 10.3% (or only 0.1% off the rate used by plaintiff’s real property appraiser).

The court adopted this rate as more credible, citing the MAI expert’s “extensive research of numerous databases.” It rejected the BV expert’s rate, finding it “too speculative” and his reasoning “unclear.” Read the complete digest of Navigato v. SJ Restaurants, LLC, 2011 WL 69099 (D. Kan.)(Jan. 10, 2011) in the April 2011 Business Valuation Update; the court’s decision will be posted soon at BVLaw.

Show your work to avoid a Daubert challenge

In last week’s BVR webinar “The Latest on Motions to Exclude Financial Experts: The Now-Routine Trial Tactic that Works,” Robert M. Lloyd (University of Tennessee College of Law) and Jonathan Dunitz (Friedman Gaythwaite Wolf & Leavitt) offered several suggestions for writing a report that will reduce your vulnerability to Daubert challenges.

“The first thing is to use the Daubert factors in your report,” said Professor Lloyd. Second, show your work. “I sound like a middle school teacher in an arithmetic or an algebra class, but it's really important to let the court know exactly what you did – all the steps, show what you did, explain the reasoning step by step in detail – and write it in a language that the judge can understand.  Define and explain technical terms.”

“The other thing you need to remember is that ultimately, if the case is tried, you'll be speaking to jurors who will probably have even less understanding than the judge does, added Dunitz.  “So it's really important to think in those terms and, from the very beginning in writing your report, to remember that you're ultimately going to have to explain this to complete novices and be able to explain it in a way that they will understand and accept as being accurate.”

Valuing a bank?  Learn from the experts tomorrow

Tomorrow, (Thursday, February 17) Andrew Gibbs (Mercer Capital) and Chip MacDonald (Jones Day) are featured in the webinar “Valuing Banks,” the latest installment of BVR’s Industry Spotlight Series. The two experts will provide listeners with all they need to know when approaching a banking institution for a valuation assignment.  For more information or to register, click here.

AICPA FVSEC submits comments to the DOL

The AICPA Forensic and Valuation Services Executive Committee (FVSEC) recently sent the DOL a comment letter opposing the Department’s proposal to change the definition of the term “fiduciary.” According to the FVSEC, “we believe the DOL should not change the definition of fiduciary, rather we believe the DOL should implement rules to ensure only qualified individuals prepare valuations for benefit plans and that individuals follow recognized valuation standards. Our reasons for concern are detailed below:”

  • Incompatible with the Internal Revenue Service’s requirements for an independent appraisal of employer securities;
  • Does not address the underlying issue of proper qualifications and standards for performing valuation services;
  • Will increase the cost of valuation services for ESOP plans; and
  • Will restrict the number of valuation specialists willing to do valuations for ESOP plans.

According to the Journal of Accountancy, Robert Reilly (Willamette Management Associates) is expected to speak at the hearing on the AICPA’s behalf at the DOL hearing on March 1 in Washington.

Should you use NPV when valuing a drug development project?

The Licensing Executives Society International (LESI) article of the month, “The Valuation Of Drug Development Projects—Part 1” by Sangeeta Puran (Mayer Brown International) addresses valuation theory as it relates to drug discovery and research. Says Puran:

“The purpose and scenario for which a valuation exercise is undertaken, and by whom it is undertaken, ultimately explains the method used to assign a monetary value to a drug development programme. In the case of VCs assessing the investment propositions offered by early stage projects, NPV modelling is not favoured.”

Part II of the article will address analysts’ approach “ together with an analysis of the valuation issues in acquisition, licensing and partnering negotiations.” Stay tuned.

Where expert-attorney communications and Mad Men meet

Hat tip to the Forensic and Valuation Reporter for the link to Damon W.D. Wright’s (Venable LLP) article “Expert Discovery Returns to the Past,” Wright’s provides an amusing, yet informational take on the recent change to Federal Rules of Civil Procedure Rule 26 which affects discovery related to expert witnesses. Says Wright:

“What do skinny ties, butter, and privileged attorney-expert communications have in common? They are all making a comeback. In the days of Don Draper of the hit television show “Mad Men,” attorneys wore narrow neck-wear and ate fat-laden breakfasts. They also corresponded with testifying experts about case strategy without losing a wink of sleep because the communications were generally protected from discovery.”

An improved resources to find web pages that were available as of your valuation date

The Internet Archive's Wayback Machine is a great resource for business appraisers who are looking for web pages as of a particular date in the past or are trying to find material that is no longer available on the web. The new BETA version offers improved search navigation and more data is available on each page.  Currently the archive has more than 150 billion archived web pages – some pages date back to 1996. Caveat: the archive doesn’t offer every change made on every single web page, and it usually takes six months before an archived page becomes available.  A URL is necessary­–you can’t search the Wayback Machine by keyword. And remember, it is a BETA version, so the tool may be buggy and unstable.  Still…what a fantastic way to “prove” what was “known or knowable…”

Further CPA reminder:  Zyla shares his option pricing modeling expertise next week

On February 24, Mark Zyla, one of the profession’s most recognized instructors, will host the Advanced Workshop on Option Pricing Modeling, an intensive four-hour clinic on the myriad of uses for OPM.  Through hands-on examples and case studies Zyla will lead attendees through all they need to know when choosing, implementing, and analyzing OPM analysis.  For more information or to register click here.

AICPA launches new family law conference to fill the gap between its divorce valuation conferences with the AAML

Can’t wait for the AICPA/AAML event in 2012?  Jerome Johnson (Burrage & Johnson, CPAs), and Chair of this new event describes the debut program as a must-attend “for practitioners considering making the leap into the field of litigation support within the family law arena – as well as for those who want to want to expand their knowledge base.”  There will be a mix of well-known national speakers and authors presenting on subjects attendees will encounter on a regular basis while working on matrimonial law engagements. You don’t what to miss the inaugural bi-annual AICPA Family Law Conference.”  The conference is May 18-20 at the Bellagio in Las Vegas.  For complete agenda and registration details click here.

The countdown ends – Duff & Phelps Risk Premium Calculator launch webinar Friday
It delivers four cost of equity estimates… it looks up the risk free rate for you… it considers industry specific risk… it instantly creates Excel, HTML and PDF versions of your results… and it was designed by Roger Grabowski.  Quite possibly the only thing the Duff & Phelps Risk Premium Calculator doesn’t do is brew your coffee.  This Friday, February 18th, at 10 a.m. PST/1 p.m. EST marks the time that Jim Harrington will debut the Calculator and answer audience questions.  Be a part of the hour-long program and you’ll also get a special offer exclusive to webinar attendees.  One CPE credit is available.  To register click here.


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Copyright © 2011 by Business Valuation Resources, LLC
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February 17, 2011
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