- 9 -
Risk-free rate 7.1
+ Equity risk premium 7.4
= Average market return 14.5
+ Risk premium for size 5.1
+ Other risk factors 5.0
= Net cash-flow discount rate 24.6
+ Net earnings discount-net cash-flow discount 0.0
= Net earnings discount rate 24.6
- Average growth rate 5.0
= Net earnings cap rate for next year 19.6
/ 1 + growth rate 1.05
= Net earnings cap rate for current year 18.7
Petitioner’s expert started with the risk-free rate of return for
the long-term Treasury bond on September 30, 1991. He consulted
Ibbotson Associates 1992 Stocks, Bonds, Bills and Inflation
Yearbook, to obtain the historical equity risk premium for stocks
and the premium for small company stocks. He determined an
additional premium of 5 percent was warranted when comparing IHC
to the public companies. Petitioner’s expert considered IHC’s
net income and cash-flow to be the same because its capital
expenditures approximated depreciation. He assumed a growth rate
of 5 percent. Petitioner’s expert converted the after-tax
capitalization rate of 18.7 percent to 31.2 pretax, using a 40-
percent tax rate. He then concluded that the buildup approach
yields a pretax earnings multiple of 3.2.
Petitioner’s expert then stated that, in FMI’s experience
with actual transactions involving privately owned construction
companies, the pretax P/E ratios ranged from 3 to 5. No data on
these transactions appear in his report or elsewhere in the
Page: Previous 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Next
Last modified: May 25, 2011