Page 36 - Economic Damage Calculations

Discount Rate as Reinvestment Rate

Some court cases discuss the damages award as an amount that, if reinvested, will replace the plaintiff’s
lost economic income. fn 8 For many cases, this damages measurement test suggests that the discount
rate for the projected but for lost cash flow and the assumed reasonable, prudent reinvestment rate avail-
able to the plaintiff should be in parity. In other words, the degree of risk premium included in the dis-
count rate and reinvestment rate should be equal. However, this assumption may not be appropriate in
all cases, because the plaintiff may not have available an investment with a level of risk that the plaintiff
could have managed in a manner similar to the impaired business. Without such an investment, to
achieve the same level of return, the plaintiff may be forced to reinvest in a financial instrument or busi-
ness that possesses a higher degree of risk than what the plaintiff would have experienced in the but for
world.

Alternatively, some experts believe that damages should be determined without regard to what a given
plaintiff may do with the damages award. These experts believe that the risk associated with the lost in-
come stream should be based on the value of the lost income stream, not on how the plaintiff may or
may not reinvest the damages award.

fn 7 James M. Patell, Roman L. Weil, and Mark A. Wolfson, "Accumulating Damages in Litigation: The Roles of Uncertainty and
Interest Rates," Journal of Legal Studies (June 1982); and Roman J. Weil, "Compensation for the Passage of Time," Chap. 37 in Liti-
gation Services Handbook: The Role of the Accountant as Expert, 2d ed, eds. Roman L. Weil, Michael J. Wagner, and Peter B. Frank
(New York, NY: Wiley), 1995. A remaining difficulty in such an approach is how to reduce to certainty equivalents.

fn 8 See the appendix in this practice aid for a list of resources and case law on this topic.

34 © 2020 Association of International Certified Professional Accountants