Page 28 - Economic Damage Calculations

Transaction as the Subject of the Dispute

A transaction between two parties may be the subject of the dispute. In this type of matter, the elements
of the subject transaction may be debated, including representations of the subject entity’s revenues,
costs, earnings, assets, and liabilities. In such circumstances, it is not uncommon for the transaction that
actually occurred to be recast under an alternative set of but for circumstances.

For example, the purchase price of a transaction may have been set using an income approach method,
such as a discounted cash flow calculation, or a market approach method. Each of these valuation meth-
ods incorporates assessments of risk and uncertainty. If revenues or earnings employed in the original
computations had been overstated by 10 percent, it may be instructive to understand the price impact
given different but for facts known as of the time that the price was set and paid. Typically, a similar
valuation method to that employed in pricing the original transaction will be used for comparison and
simplicity. However, this re-creation of the original transaction may involve the use of a discount rate or
pricing multiple in a manner that may or may not parallel the subject transaction. This may be the case if
the but for facts about the income stream were to imply a different level of future uncertainty. fn 2

Personal Injury, Wrongful Death, and Wrongful Termination Cases

These types of cases typically relate to the claims of lost earnings of an individual, with compensatory
damages for diminished future earnings discounted to present value as of the date of trial or judgment.
Largely due to courts’ rulings on such cases and income tax laws, a distinction is often drawn in per-
forming (1) an individual’s lost earnings calculation compared to (2) a business entity’s lost income cal-
culation. It is generally accepted that the discount rate to be applied in these matters (after consideration
of earnings growth) should not submit the plaintiffs to undue risk considerations, which has often result-
ed in the use of risk-free discount rates. The justification of such a rate is that this rate will permit the
plaintiff to replicate the lost earnings stream by reinvesting the amount paid in a judgment in the "best
and safest investments."

Once it is assumed that the injured worker would definitely have worked for a specific term of
years, he is entitled to a risk-free stream of future income to replace his lost wages; therefore, the
discount rate should not reflect the market's premium for investors who are willing to accept
some risk of default. (Jones & Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523, 537 [1983])

In some jurisdictions and cases, the concept of discounting in personal injury and lost individual earn-
ings cases has been addressed with the total offset method, which uses a net discount rate of zero, with
the inflation and real wage growth rate assumed to offset completely the discount rate. fn 3 Although the
total offset method simplifies the damages analysis, some courts have criticized the use of this method,
suggesting that a real discount rate is more appropriate. fn 4

fn 2 The expert may wish to consider other guidance applicable to transaction-related damages, including, for example, AICPA FVS
Section Practice Aid Mergers & Acquisitions Disputes.

fn 3 Paducah Area Public Library v. Terry, 655 S.W.2d 19 (Ky. Ct. App. 1983); Beaulieu v. Elliott, 434 P.2d 665 (Alaska 1967); State
v. Guinn, 555 P.2d 530 (Alaska 1976); Kaczkowski v. Bolubasz, 491 Pa. 561, 421 A.2d 1027 (1980).

fn 4 O'Shea v. Riverway Towing Co., 677 F.2d 1194, 1199 (7th Cir. 1982). See also Doca v. Marina Mercante Nicaraguense, S.A.,
634 F.2d 30, 39 n.10 (2nd Cir. 1980) ("... there is substantial opinion that during periods of stable rates of inflation, the real yield of
money, whether constant or slightly fluctuating, is approximately 2%").

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