Inflation appears to have peaked, per Kroll

The latest cost of capital infographic from Kroll says that inflation seems to have topped out toward the end of 2022. Inflation estimates over the long term rose from 2.0% in June 2020 to 2.9% in October 2022 but declined to 2.4% at the end of December 2022. Long-term inflation expectations are a key starting point to evaluate the long-term growth rate used in the terminal year for a DCF analysis.

Cost of capital inputs: The same infographic says that, as of Jan. 17, 2023, Kroll’s recommended U.S. equity risk premium (ERP) is 6.0% and the normalized risk-free rate is the higher of 3.5% or the spot 20-year U.S. Treasury yield as of the valuation date. This guidance is effective when developing USD-denominated discount rates as of June 15, 2022, and thereafter.

IRS hits taxpayer with gross valuation misstatement penalty

Easement cases before the Tax Court can offer some interesting insights and guidance to BV professionals. A recent case involved the valuation of a conservation easement donation for a charitable deduction. The deduction is figured by determining the fair market value of the property before the donation and subtracting the FMV after the donation. In this case, the donation involved an easement on undeveloped real estate. The opposing valuation experts agreed that the highest and best use for the property was as a residential subdivision and development. But the donors’ valuation expert came up with a value that was “incredible as a practical matter,” as the court put it. He mischaracterized the zoning according to the court and valued the property as fully developed. He also did not consider a prior transaction involving the property. The IRS expert concluded that the valuation should be based on the property being undeveloped. The two valuations were miles apart.

The court sided with the IRS expert, and, because the donors’ valuation was 200% or more of the correct valuation, they were hit with the 40% gross valuation misstatement penalty. Plus, the court disallowed the deduction because the donors failed to get proper substantiation of the donation—the easement deed alone was not sufficient.

The case is Brooks v. Comm’r, T.C. Memo 2022-122; 2022 Tax Ct. Memo LEXIS 122, and a case analysis and full court opinion are available on the BVLaw platform.

Year-end 2022 data now in the Cost of Capital Professional

Year-end 2022 data, including equity risk premia, CRSP decile size premia, and industry betas/IRPs, are now available in BVR’s Cost of Capital Professional platform. The platform is a simple, transparent, and cost-effective service for estimating the cost of capital and is designed to bring more professional judgment and common sense back into the process, which has become too much of a complex “black box” of applied mathematics. It supports the buildup method and CAPM calculations for any valuation date. It also gives you the flexibility to choose the start year for historical return data based on what segment of history you believe best offers a reasonable basis to make estimates of expected future returns. For a personalized demo of the platform, click here.

Extra: In a head-to-head test, all of the main cost of capital datasets, including Kroll’s Navigator, BVR’s Cost of Capital Professional, and Pepperdine, produced similar cost of equity estimates. See this article in the February 2023 issue of Business Valuation Update.

Report drills down on dental practice financials

PKF O’Connor Davies has released its 2022 edition of “Dental Practices by the Numbers,” which provides key financial benchmarks. This year’s edition contains more statistics and metrics than past reports. Average collection and expense amounts—including staff compensation, services costs, facilities costs, and administrative costs—organized by practice and by individual general dentist are reported. In addition, the report contains an average statement of collections and expenses for specialists, including pediatric dentists, oral surgeons, and periodontists. To download the free report, click here.

Final issue of Willamette’s Insights focuses on best practices

The Winter 2023 issue will be the final one for Insights from Willamette Management Associates. The firm will replace it with a new digital publication, Perspectives, which will be a quarterly. The first issue will be out in April, and you can sign up if you click here. The last issue of Insights is edited by Robert Reilly and has articles on best practices in such areas as S corps, damages, economic obsolescence, fair value measurements, executive compensation, and more. The issue is available if you click here.

Global BV News

IVSC’s Talbot gives his views for 2023

Several key trends are shaping the valuation profession, namely environmental, social, and governance (ESG) factors, technology, and the increasingly global nature of business, says IVSC chief executive Nick Talbot. Also, ongoing uncertainty throughout the world acts as a “double-edged sword,” making the “valuer’s role more complicated but also increases the demand for high quality valuation skills as investors look for additional advice in times of change.” He also identified several challenges for 2023 and beyond, including the growing complexity of the business world and the growing demand for transparency and accountability. “As the global economy continues to evolve, the demand for high-quality valuations will only increase, making it an exciting time to be a valuer,” he says. “Those who are able to adapt to the trends and challenges of the profession will be well-positioned to succeed in the years ahead.”