‘Levered DCF’ falls to Daubert

BVWireIssue #92-1
May 5, 2010

Daubert challenges to financial experts are de rigueur; at least half a dozen new cases came in this month, each attacking the relevance and reliability of the valuation evidence (or the valuator’s qualifications). Daubert motions now play the same role as depositions: both “try” the evidence—and exact costs from an opposing party—prior to trial.

In some of the more complex bankruptcy and securities litigation cases, however, Daubert challenges test what appear to be “standard” methods, from proven experts.  For example, an otherwise qualified expert valued a Chapter 11 debtor under a “levered” discounted cash flow (DCF) approach. The method simply adjusted the typical DCF elements to fit the debtor’s reorganization plan, the expert said. Specifically, he assumed zero projected cash flow until the debtor’s proposed sale in 2012, at which point he subtracted net debt and preferred stock (labeling this “terminal value”) and applied a discount rate (determined from cost of equity) to reach an equity value.

Although the expert may have used traditional terminology, there were “no substantive similarities between the generally accepted DCF method” and his “levered” method, the federal bankruptcy court found. Further, the expert made “multiple novel assumptions,” such as an assumed sale of the company, and a discount rate that failed to account for both the cost of debt and equity. It may have met the facts of the case, but his method failed to match the “intellectual rigor” required of an expert valuation, and the court disqualified the untested approach under Daubert. Read the complete digest of In re Young Broadcasting, Inc. (S.D.N.Y., April 19, 2010) in an upcoming (June 2010) Business Valuation Update™; the court’s opinion will also be available at BVLaw™.

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