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1. Assumed Rate of Return
Both experts used the build-up approach to calculate the
assumed rate of return for the tax years in issue. The build-up
approach starts with the risk-free rate of return for the year in
issue, and three adjustments are made: An equity risk
adjustment, a size adjustment, and a company-specific risk
adjustment. The only adjustment the parties do not agree on is
the company-specific risk adjustment. This adjustment cannot be
found in reference materials; rather, it requires a factual
determination.
Dr. Sliwoski, petitioner’s expert, found a company-specific
risk adjustment of negative 2.5 percent because he determined
that petitioner was subject to minimal business risks and
extremely minimal financial risk. By contrast, Mr. Herber,
respondent’s expert, concluded that the company-specific risk
adjustment should be positive 5 percent for each tax year in
issue. Mr. Herber considered petitioner’s size (as measured by
annual sales), industry risks, lack of management depth, and the
competitive nature of the drywall construction business as
factors in making the company-specific adjustment.
Having reviewed the parties’ respective positions, we
disagree in part with each expert’s company-specific risk
adjustment analysis. We find the total company-specific risk
adjustment to be negative 2 percent for each year in issue. We
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