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Obviously, the particular capitalization rate that is
selected has a significant impact on the ultimate valuation and
is intended to reflect risks or volatility associated with a
company’s income stream and seeks to reflect what a stockholder
would require for a rate of return on an investment in the
company being valued. The more risky and volatile the income
stream is perceived to be, the higher the capitalization rate.
Conversely, the more stable the income stream is perceived to be,
the lower the capitalization rate.
In this case, the estate’s experts calculated a
capitalization rate of 30.5 percent for TPC. This capitalization
rate was calculated by the estate’s experts by adding together
the following risk factors and percentages:
(1) 6 percent to reflect a risk-free rate of return (equal
to the May 1, 1998, yield on 20-year U.S. Treasury
securities);
(2) 7.8 percent to reflect an equity-risk premium (to
compensate an investor for the risk of investing in
stocks as compared to long-term U.S. government
securities, reflecting the percentage by which the
average annual return on large corporate stocks exceeds
the average annual return on U.S. government
securities, as provided in the Ibbotson Associates’
Stocks, Bonds, Bills & Inflation Yearbook for the years
1926-97);
(3) 4.7 percent to reflect a small stock risk (to
compensate an investor for the risk of investing in
stock of a small corporation as compared to a large
corporation, reflecting the percentage by which the
average annual return earned on small corporate stock
exceeds the average annual return on large corporate
stock, as provided in the Ibbotson Associates’ Stocks,
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