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average of $19,263.2 He took the average of these two figures,
or $18,687. Finally, to calculate earnings for 1993, the year of
decedent’s death, he increased the average earnings figure by an
inflation factor of 4 percent, for a total of $19,435. This was
the income stream to which he applied the capitalization rate.
To calculate the capitalization rate, Mr. Egan began with
the rate of return for a risk-free investment, using the rate of
return on long-term U.S. Government bonds as of the date of
decedent’s death, or 7.53 percent. He then attempted to quantify
the risk inherent in an investment in JFI, using a study by
Ibbotson Associates that estimated the historical rate of return
of stocks as compared to the historical rate of return of long-
term Government bonds. On the basis of the Ibbotson study, Mr.
Egan concluded that investments in smaller companies in general
required a 12.4-percent greater return than investments in
Government bonds. But Mr. Egan believed that JFI was an even
riskier investment than the smaller companies represented in the
Ibbotson study.3 He, therefore, added an additional 10 percent
to the capitalization rate to account for the risk inherent in
investing in JFI in particular. This gave him a total of 29.93
2 He gave the earnings figure from the most recent year,
1992, a weight (or multiplier) of 5, the figure from the
preceding year, 1991, a weight of 4, and so on, with the figure
from 1988 receiving a weight of 1. He then summed the products
and divided the total by 15, the sum of the weights applied.
3 According to Mr. Egan, JFI was much smaller than the
smaller companies represented in the Ibbotson study.
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