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Respondent argues that applying a discount for Deft's
potential environmental liabilities is improper because these
liabilities have already been included in the unadjusted value
calculation under the income method and the market method. We
agree with respondent as to the market method but disagree as to
the income method.
Under the income method, HML discounted Deft's future cash
flows to present value using a discount rate determined by the
Capital Asset Pricing Model (CAPM). The discount rate represents
the company's expected rate of return on equity.
The CAPM uses several variables including a variable
representing the company's volatility relative to market returns
(Beta). Deft's Beta was determined based upon the Betas of eight
similar paint and finishing companies. Respondent contends that
these paint and finishing companies had Betas considerably higher
than other companies’ because most paint and finishing companies
have potential environmental liabilities that make the return on
investment in these companies more volatile. Respondent argues
that these Betas already include the potential environmental
liabilities of these companies; therefore, it is improper to also
consider these liabilities in determining the proper discount.
We disagree with respondent. Respondent provided no
evidence at trial that the Betas of the eight comparable paint
companies were higher than normal due to potential environmental
liabilities faced by these companies.
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