Court of Chancery of Delaware, 1990.
Appraisal Action concerning friendly merger of Technicolor into a shell corporation.
-An appraisal action is a judicial, not inquisitorial proceeding.
Parties, not the court, establish the record and the court is limited by record.
-Court must look at the models created by the expert, can not create a completely independent judicial model.CAPM Model
-Estimates the cost of debt (on an after tax basis for a company expected to be able to utilize the tax deductibility of interest payments) by estimating the future cost of borrowing; it estimates the future cost of equity through a multi-factor equation and then proportionately weighs and combines the cost of equity and the cost of debt to determine the cost of capital.
-Used widely to estimate a firm’s cost of equity capital.
-Identifies a risk-free rate for money and identifies a risk premium that would be demanded for investment in the particular enterprise in issue.
-Risk free rate: derived from gov’t treasury obligations.
For a traded security, market risk premium derived in 2 steps.
1) market risk premium calculated: expected rate of return for representative stock market index minus riskless rate.
2) Individual company’s systematic risk (non-diversified risk associated with the economy as a whole as it affects the firm) is eliminated.
-This is the CAPM, represented by Beta
-Beta measures relative volatility of firm’s stock price relative to market movement generally.
-Higher Beta = the more volatile or risky the stock of the subject company.
-The riskier the investment, the higher its costs of capital will be.
CAPM cannot determine a uniquely correct cost of equity.
-Generally considered acceptable for estimating the cost of equity capital component of a discounted cash flow modeling in the financial community.
-Small Capitalization effect or premium.
-Court says that although Technicolor may qualify as a small cap company, the particulars of this situation are different than many small cap companies.
1) old, not new company.
2) existed in a stable industry (motion pictures)
3) Industry was an oligopoly, technicolor was a leader.
4) “brand name” identification.
-Technicolor should not get the premium.