RABCPA PC Blog
When someone mentions the word discount rate, you often think of the Federal Reserve Discount Rate, Federal Funds Rate, Expected Rate of Return, Cost of Capital, Required Rate of Return or Capitalization Rate. Most of these terms mean the same thing or are derived from each other. However, the Federal Reserve Discount Rate is the rate at which the Federal Reserve loans money to banks. The Federal Funds Rate is the rate at which the Federal Reserve expects banks to loan money to each other. We are not discussing the Federal Reserve Discount Rate or the Federal Funds Rate in this video.
In this video we will discuss rates used to analyze businesses, cash flow or other financial decision making.
Some people have what is called a Personal Discount Rate. This helps them make financial decisions the same way a discount rate can help a corporation or investor make decisions. For example, if someone offered to pay you $100 for 10 years or a lump sum of $853 which would you select? That would depend on what your personal discount rate is. If it was 3% either one would be the same. If, however it was 4% you would be better off taking a lump sum payment.
The discount rate is a very important tool that you can apply to investment decisions, valuations or analyzing different cash flows. The great importance of the discount rate is not that it provides you with the correct answer for investment opportunity, but rather it provides a framework under which you can analyze the investment and develop a much deeper understanding of your choices.
The definition of discount rate is the rate of return used to discount future cash flows back to the present value.
One of the top things to decide is how you calculate or find your discount rate. Typically, the best way to determine a discount rate for a company is to see what that company is required to pay investors to invest in the business. For example, if a company needs to pay investors 15% to make investments in the business then that would be there discount rate. Think about it this way, if they are borrowing at 15%, they would need to make at least 15% in the company otherwise they would be destroying value.
A simple way to think about this is to assume it will cost you $100 to make a product, you would have to sell it for at least $100 otherwise you would be losing money. Preferably you would like to sell it for $125 or $150 and make a profit. Discount rate or your cost of capital is the same concept.
Sometimes, companies will use what is called the buildup method in order to find their discount rate.
The buildup rate can be obtained by doing the following:
Equity Risk Premium
Specific Company Risk Premium
From this you will be able to determine the discount rate.
Once a company has its discount rate it just has to subtract the growth rate to get what is called a capitalization rate 14.05% (17.04-.03).
The below chart shows an analysis of Free Cash Flow and utilizes both a discount rate and capitalization rate to arrive at the present value of 192 million dollars. This is something you do not see in any textbooks and most professors do not go into this, or at least explain it this way.
Posted June 16, 2020 by Business Valuations
Representing Yourself in Court
Every year in the United States millions of people attempt to navigate the US court system without an attorney. In some states as many as 80% to 90% of litigants are unrepresented.
When someone represents themselves in court they are referred to as “Pro Se” which is Latin for “on one’s own behalf.”
Our firm is contacted frequently by Pro Se clients who want to retain us for expert testimony.
We recently had a case where we testified in court, and both parties were Pro Se. Obviously the judge was not too happy with the situation because this meant extra work for him. As Abraham Lincoln said, “a man who represents himself has a fool for a client”. There is of course some truth to this. In that case, it worked out for our Pro Se client since she was able to afford extensive forensic accounting and also see the case through to the very end. The result of that case was that she was able to obtain a significant alimony and child support. There are many successful Pro Se clients who are able to take on adversaries in court and win against experienced lawyers.
Anderson et al. Pacific Gas and Electric; Erin Brockovich, $133.6 settlement
Two books to review if you are thinking about going Pro Se are, Represent Yourself in Court and Legal Research. Both can be found on nolo.com; a good site for Pro Se information. You probably should review these books and gain an understanding of the legal system before undertaking a legal matter and representing yourself. If you are unwilling to put the time in, you may want to re-think going Pro Se.
From my experience people who get into complex litigation matters often run out of money and/or time. This is why so many people go Pro Se, the benefits are that you do not have to worry about paying hundreds of thousands of dollars in legal fees and you can have the stamina to pursue your case for years. Many attorneys are not able take on complex cases unless they can bill hundreds of thousands of dollars per year.
Reason to go Pro Se:
You know your case better than anyone
You can spend money on experts and court reporters, etc.
A lawyer will give you only representation that money can buy
You have the right to represent yourself in court
You are capable of representing yourself in court
You will likely work much harder than your attorney
You can not afford an attorney
You are not intimidated by the legal process
You will not run out of money and/or time if you are Pro Se
One satirical look at Pro Se clients can be seen by viewing the YouTube clip from My Cousin Vinny, the movie. https://www.youtube.com/results?search_query=my+cousin+vinney
The biggest mistakes that Pro Se clients make are:
Spending too much time reacting to the other attorneys’ motions and discovery request. You need to be proactive and take the offensive, send out interrogatories, take depositions, make motions.
Lacking confidence. You need to be confident even though you may not know all the pitfalls.
Not spending money on experts and court reporters. The money supposedly saved by not hiring an attorney should be spent on necessities such as court reporters and experts.
Overreacting to attorneys posturing. Remember to focus on the facts of the case not the posturing, antics and other judicial biases.
You need to research and understand how to research if you are going to go Pro Se.
Overconfidence: you need to be humble and do not overestimate your abilities.
The legal system is not set up to help or benefit Pro Se clients for the most part so do not expect to be treated fairly.
Posted May 20, 2020 by Educational Videos
Companies create value when an investment in a business yields returns in future cash flow.
Generally, when return on invested capital is higher than the opportunity cost (lost rate of return), value is created.
The two key metrics that indicate if a company is making money are growth and return on invested capital.
If you want to judge fairly a management team of a company, you simply have to look at the growth in sales and the return on invested capital over a five to 10-year period. A great deal of work that we perform requires us to evaluate the profitability of businesses and value them. Two key metrics that are the most important are growth and return on invested capital. With these two metrics you can get an objective view of the company.
When I talk about growth I am mainly talking about sales growth; how fast is a company growing, are sales increasing at 5% to 20%, or are they declining?
Return on invested capital is a bit trickier. How much capital a company has depends on not only the equity but also long-term debt minus cash. This is then divided into net income to determine return on invested capital.
I typically like to look at these over a long period of time to get an understanding of how well the business is being managed. Especially if it is a publicly held company or a well-run private company.
Let us look at a real-life example:
One free site that I like for financial information on public companies is Yahoo Finance. The following chart was compiled from information on that website.
Litigation involving MetLife; evaluation of company performance:
Posted May 4, 2020 by Business Valuations