Page 48 - Economic Damage Calculations

American Federal Bank, FSB v. United States (72 Fed. Cl. 586 2006)

This case is notable because the court did not adopt the risk-free discount rate proposed by the plaintiff’s
expert or the risk-adjusted discount rate proposed by the defendant’s expert. Instead, the court adopted a
discount rate that it characterized as risk-adjusted, but which did not depart significantly from a 10-year
U.S. Treasury bond observable at times relevant to the dispute. The particular circumstances involved
American Federal Bank, which sued the U.S. government for changing the terms by which a bank could
determine its regulatory capital. Lost profits were sought in connection with the lost opportunity caused
by dividends paid on newly issued capital, as required by the changes. The plaintiff proposed a risk-free
rate of 5.5 percent. The defendant proposed a risk-adjusted rate of 12 percent. Citing Energy Capital, the
appeals court determined that a risk-adjusted rate was required.

The court considered rates proposed by the parties, including the 8.6 percent 10-year U.S. Treasury bond
rate in effect at the time of the breach and the 4.5 percent rate on the 10-year U.S. Treasury bond at the
time of trial, and it concluded that a reasonable risk-adjusted rate was 8 percent.

In re Magna Cum Latte, Inc., 2008 WL 2047937

This case provides another example when a court independently selected a discount rate, which, in this
instance, was a risk-adjusted rate that struck a balance between the discount rates offered by the oppos-
ing experts. The case involved Magna Cum Latte, which sought lost profits pursuant to a lease dispute
with Diedrich Coffee, Inc. The plaintiff’s expert used a 6 percent growth rate and a risk-free discount
rate over 5 years. The court concluded that a risk-adjusted rate was required under California law, stat-
ing, "While a risk-free discount rate cannot be justified, nor can the extreme risk reflected in the 27.7
percent rate utilized by Diedrich’s expert. The more reasonable discount rate is 15 percent." Adopting a
2.5 percent growth rate, a 5 year damage period, and a 15 percent discount rate, undiscounted damages
of $570,000 were reduced to $371,000.

Burger King Corp. v. Barnes, 1 F. Supp. 2d 1367 (S.D. Fla. 1998)

This dispute related to the breach of a franchise agreement entered into between Burger King Corpora-
tion as franchisor and Zuri Barnes as franchisee. The court found that Barnes’s abandonment of the
franchise agreement constituted a material breach of contract. Barnes had agreed to pay Burger King a
royalty of 3.5 percent of monthly gross sales. At the time of the breach, 17.5 years remained in the 20-
year franchise agreement. The projected lost royalty income to Burger King for the remaining term of
the agreement was reduced to present value at a discount rate of 9 percent. The court did not provide a
rationale for its selection of this rate. At that time, average yields on U.S. Treasury securities with 10–30
year maturities were in the 5 percent range. Therefore, the court appears to have accepted a discount rate
that was adjusted for risk at least to some degree.

Kool, Mann, Coffee & Co. v. Coffey, 300 F.3d 340 (3d Cir. 2002)

In a dispute over the sale of a marina and a houseboat rental business, the plaintiff claimed that the de-
fendant failed to pay an agreed-upon purchase price. The defendant counterclaimed, arguing misrepre-
sentations on the part of the plaintiff. The court determined that the remaining balance of the purchase
price would be calculated, in part, by (1) growing adjusted cash flows by 7.5 percent per year for 15
years and (2) discounting the projected cash flows to their present value using a discount rate of 18.5
percent. The 18.5 percent discount rate was offered by the plaintiff and not disputed by the defendant.

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