If you do tax appraisals, you are probably being asked for valuations as of yearend 2008, now that most companies have filed returns and issued financials.
Reports completed after the valuation date are called retrospective appraisals. One of their key rules is Revenue Ruling 59, Section 3, Paragraph 3. This says that only information known or reasonably knowable as of the valuation date is relevant. Stated another way, we have to place ourselves back as of the valuation date and consider only (as Howard Baker, of Watergate fame, said) “What did we know and when did we know it?” We also have to consider what we did not and could not know. This is imperative, because the world economy has settled down somewhat since December 31, 2008. We may even be seeing signs of recovery. Not so, back at yearend!
The stock market was plummeting and volatility was soaring.
- Bank credit was frozen and banks were starting to fail.
- Wall Street was convulsing, collapsing, and consolidating.
- Home prices were falling, foreclosures rising, personal wealth dwindling, job security was at a nadir, and consumer confidence was shot, leading to dramatic declines in consumption.
- Business psychology was horrible, capital outlays were being cut, and major layoffs were imminent.
- Investor psychology could be summarized in one word “terrified”.
- It was unclear how deep and long the recession would be.
- The Madoff scandal made everyone worry about the safety of their money.
- The change of Presidential administration and party affiliation was a huge unknown: what was he going to do?
- The viability of General Motors, Chrysler, the domestic automobile industry, and its supply chain were at grave risk.
- And more … I have probably missed some things.
Many of these issues have now been resolved, mitigated, or “dealt with” in one form or another. It’s a new and different ballgame today. WE HAD NO IDEA ABOUT THAT BACK THEN!
As a result, as of yearend 2008, expected returns were way down and risks were way, way up. Bottom line: I would not argue if an appraiser added a 5%, 10% or perhaps even a 15% “special circumstances” equity risk premium to their estimates of the cost of capital. I’ve done it myself! Do not let anyone tell you that you should ignore the “hiccup” at yearend 2008;it was much worse that that