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used a hypothetical investment in capital for purposes of
computing a fair return on the capital. Use of the hypothetical
investment in capital resulted in a smaller fair return for most
years. The smaller fair return resulted in a larger excess,
which Mr. Reilly accumulated and used as the amount of
undercompensation. Mr. Reilly used the more realistic
stockholders equity shown on petitioner's Forms 1120, however, to
compute compensation using the Watson Wyatt formula. We reject
this inconsistency.
As an additional analysis, Mr. Reilly calculated the average
compound annual returns to petitioner's stockholders. He used
$315,766 (approximately twice the price petitioner paid for
Clifford's 1,000 shares of stock) as the value of the
stockholders' initial investment on October 31, 1986, and three
different measures of petitioner's stockholders equity. Using
his fair return of invested capital analysis and the estimated
value of $1,834,375 as of October 31, 1996, Mr. Reilly calculated
that the average annual after-tax return over the 10-year period
from 1986 to 1996 was 19.24 percent. Using the $3,133,877 book
value of stockholders equity as of October 31, 1996, Mr. Reilly
calculated that the average annual after-tax return over the 10-
year period was 25.80 percent. Finally, using the $1,150,000
purchase price Dennis paid to Curtis for his 25 percent of
petitioner's stock in November 1997 to determine an estimated
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