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As a third approach, Mr. Dorman explained that the income
approach is used to determine the fair market value of an ongoing
business enterprise on the basis of its earning capacity. Mr.
Dorman provided the caveat that Godfrey’s management made
representations concerning future operating outcomes, but he did
not explain or provide those representations. He then annualized
the September 30, 1997, earnings, which he found to be
$3,085,615. The 4 preceding years’ earnings were then weighted,
giving the most emphasis to 1996 and least to 1993. Mr. Dorman
ignored the 1997 results “due to the cyclical nature of the
business” and arrived at normalized annual earnings of
$1,846,793. If Mr. Dorman had included the annualized amount for
1997 and used a similar approach to weighting the income results,
normalized earnings would have been approximately $2,259,334 or
22 percent larger.
Next, a capitalization rate was selected. This rate should
constitute a reasonable rate of return. Mr. Dorman referenced
the Dun & Bradstreet’s 1996-97 median after-tax return on net
worth for the boat building and repairing industry, which was
12.9 percent. He then explained that an investor would want to
receive a rate of return at least 12.9 percent; but if another
investment alternative would produce a better return with the
same degree of risk, the investor would want a better return than
the industry average.
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