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company such as petitioner, taking into account the appropriate
risk and performance characteristics of petitioner.
From his pretax operating return on net operating assets
percentages, Hakala determined an adjusted average required rate
of return of 16.77 percent. In so doing, he assumed “inflation
plus real growth will average approximately 4.0% per annum” and
grossed up for taxes. Hakala then calculated reasonable
compensation numbers for Jack such that the average required rate
of return was 16.77 percent. The values of the variables
(operating profit and three times owners’ discretionary cashflow)
that Hakala used to conclude that the average required rate of
return equaled 16.77 percent are pretax values. The 16.77
percent, however, contemplates that the values will be after-tax
values.
Hakala chose to use the Capital Asset Pricing Model
(hereinafter sometimes referred to as CAPM) to estimate
petitioner’s cost of capital. He states that CAPM is “A standard
method of estimating the cost of capital”.
Petitioner contends that CAPM “has no application to closely
held companies”, citing Furman v. Commissioner, T.C. Memo. 1998-
157. Neither Hakala nor respondent seeks to rebut petitioner’s
Furman contention. Hakala did not tell us (1) whether there are
other standard methods, (2) whether CAPM has advantages over
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