- 35 - In order to determine the cost of capital, Mr. Mitchell utilized the capital asset pricing model (CAPM).30 In his CAPM analysis, Mr. Mitchell determined a risk-free rate of return and added this to the product of beta31 and a market risk premium. Mr. Mitchell then added an unsystematic risk premium to account for WLI’s status as a small company. Mr. Mitchell used a 7.5- percent risk-free rate of return based on the market yield of 30- year U.S. Treasury bonds as of the valuation date. He determined the market risk premium using historical data published in Stocks, Bonds, Bills and Inflation by Ibbotson Associates. On 30The capital asset pricing model (CAPM) is utilized to estimate a discount rate by adding the risk-free rate, an adjusted equity risk premium, and a specific risk or unsystematic risk premium. The company’s debt-free cash-flow is then multiplied by the discount rate to estimate the total return an investor would require compared to other investments. See Estate of Klauss v. Commissioner, T.C. Memo. 2000-191 (citing Furman v. Commissioner, T.C. Memo. 1998-157). 31The application and utility of beta has been described in the following terms: Beta, a measure of systematic risk, is a function of the relationship between the return on an individual security and the return on the market as a whole. Betas of public companies are frequently published, or can be calculated based on price and earnings data. Because the calculation of beta requires historical pricing data, beta cannot be calculated for stock in a closely held corporation. The inability to calculate beta is a significant shortcoming in the use of CAPM to value a closely held corporation; this shortcoming is most accurately resolved by using the betas of comparable public companies. * * * [Furman v. Commissioner, T.C. Memo. 1998-157; citation and fn. ref. omitted.]Page: Previous 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 Next
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