- 26 -
gave no further explanation of his choice of beta and did not
provide evidence that he had investigated the betas of comparable
public companies, or even of BKC, on which his selection of beta
was based.9
After determining a cost of equity using CAPM, Mr. Shelton
purported to compute the WACC of FIC in order to arrive at a
capitalization rate. Without providing any explanation, Mr.
Shelton computed WACC in a manner that did not conform to the
accepted method. See Brealey & Myers, Principles of Corporate
Finance 465-469 (4th ed. 1991); Pratt et al., Valuing a Business
180, 184, 189-190 (3d ed. 1996). First, Mr. Shelton modified the
WACC formula by weighting FIC's debt and equity based on book
value, rather than market value, to arrive at a WACC of 11.0
percent. Considering that the parties have stipulated risk-free
rates of 11.86 percent and 14.4 percent in 1980 and 1981,
respectively, it is obvious that Mr. Shelton's result is
incorrect.
The calculation of WACC provides an after-tax figure,
because it is computed using an estimate of the firm's marginal
corporate income tax rate. After finding that FIC had a WACC of
11.0 percent, Mr. Shelton tried to convert WACC to a pretax
figure. Mr. Shelton calculated what he referred to as a pretax
9 At the time of the Recapitalization, as discussed supra,
BKC was a wholly owned subsidiary of Pillsbury. Because BKC
stock did not trade publicly, it did not have a beta. See
discussion and explanation of beta, infra pp. 28-30.
Page: Previous 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 NextLast modified: May 25, 2011