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approach will eventually lead to negative net asset value,
Dr. Spiro to the fact that Dr. Bajaj’s projected increases in
capital expenditures more than double his projected sales
increases over the 1995-1999 period.
Korbel’s financial statements for the 1985-1994 period show
that, whereas depreciation increased annually, capital
expenditures (“property, plant and equipment purchased”) have
fluctuated significantly over that same period, the low of
$2,315,000 occurring in 1990 and the high of $6,142,000, in 1991.
Average annual capital expenditures for the 1990-1994 period were
$3,817,000. Therefore, we consider Dr. Spiro’s projection of $4
million in annual capital expenditures to be reasonable, and we
adopt it. Conversely, we find nothing in Korbel’s financial
history to support Dr. Bajaj’s projection of ever-increasing
annual capital expenditures.
3. Rate of Return
The DCF method involves the computation of the present value
of expected future cashflows. The present value of a cashflow
equals the cashflow multiplied by a discount factor (less than
1). The discount factor is usually expressed as the reciprocal
of 1 plus a rate of return: Discount factor (for one period) =
1/(1 + r).8 Drs. Bajaj and Spiro agree that the rate of return
8 See Brealey & Myers, Principles of Corporate Finance 16
(6th ed. 2000) (“The rate of return r is the reward that
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