Page 27 - Economic Damage Calculations

Chapter 4

Present Value and Discount Rates Within a Litigation Context

Economic damages calculations often arise in connection with a breach of contract or tort claim. Alt-
hough similar, tort causes of action and breach of contract causes of action do not share an identical
standard for damages.

The primary aim in measuring damages is compensation, and this contemplates that the damages
for a tort should place the injured person as nearly as possible in the condition he would have oc-
cupied if the wrong had not occurred, and that the damages for breach of contract should place
the plaintiff in the position he would be in if the contract had been fulfilled. (Charles McCor-
mick, Handbook on the Law of Damages [West Pub. Co., 1935], 560)

Damages Calculation Contexts and Measures

The following sections provide a sample of different types of damages calculations and contexts that
may call for discounting in disputes.

Lost Profits Damages

Economic damages may be measured using lost profits, comparing an estimated but for scenario with an
actual/impaired scenario income or cash flow stream either for an asset, such as a product line, business
unit, or an entity as a whole. fn 1 In such a calculation, either (a) future profits may be measured in the
but for scenario and the actual scenario, with both scenarios discounted back to present value, or (b) the
difference between the two scenarios may be calculated, with the difference discounted back to present
value.

Lost Business Value Damages

In certain circumstances, such as for a breach of contract or a fraud claim, a business may be destroyed
or its value permanently impaired. In such a case, one measure of loss may be the resulting lost business
value. In such an analysis, a discount rate may be used in estimating the value of the subject business as
of a valuation date before the damages event compared to the value of the subject business after the
damages event. Frequently, this lost business value includes an income approach (discounted cash flow)
valuation method or a market approach valuation method. The income approach will typically use a dis-
count rate in the valuation, while the market approach may consider a discount rate in the process of es-
timating a direct capitalization rate or a pricing multiple, such as in calculating a terminal value.

fn 1 It may be helpful for practitioners to review the objectives and parameters of the calculation of lost profits in a commercial dis-
pute (see AICPA Forensic and Valuation Services [FVS] Section Practice Aid No. 06–4, Calculating Lost Profits, with respect to cau-
sation, reasonable certainty, foreseeability).

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