In Ohio, my home state, the law is that marital assets are valued as of the separation date. Subsequent value changes are not part of the marital estate value.
Given that, what’s wrong with the following Income Approach valuation for divorce?
The appraiser estimated cash flow to equity by weighting five years’ prior cash flows 10%-10%-10%-35%-35%. The earliest cash flows (the 10% ones) were higher than the last two (the 35% ones) due to increased price competition and the recession, which is by no means over in Ohio. The appraiser capitalized weighted average cash flow to equity at 18%, using a 21% discount rate (assume that is O.K.) less a 3% growth rate.
- Obviously, the 3% growth rate violates the legal doctrine, which says that the growth rate should be zero.
- Not so obviously, at least to me, was that the weights assigned to the historical cash flows implicitly build in growth in cash flow relative to the last historical year. In other words, weighted average cash flow for the five years is higher than what was achieved in the last one.
The second point has fed me major food for thought, since the above appraisal is one that I have to rebut as the opposing expert. Case facts (price competition and ongoing recession) suggest no growth in the subject business, and more probably continued declines. I believe that the last two years (which were pretty similar in cash flow magnitude) should together be given 100% weight with none to the three preceding years. Moreover, Ohio legal doctrine prohibits consideration of post-separation value increases.
This is a classic example of how a legal standard overrides and makes rather controversial what would be standard appraisal procedure in other contexts (taxation, compliance, or transactional). I anticipate a very interesting deposition and cross-examination on this topic!