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Valuing Economic damages

Valuing Economic Damages Experience

We provide reports on valuing economic damages, including business interruption claims and loss business value. We provide a detailed assessment of the information provided and a robust economic damages report. Past matters have included breach of contract, termination of contract and theft of intellectual property. Economic damages includes the following matters.

Breach of contract. Quantifying the business interruption and loss of profits as a result of a breach of contract. Breach occurred because the defendant failed to provide the required security services at the time of a fire event that occurred in the plaintiff’s show home. District Court.

Termination of contract. The respondents terminated a fishing agreement with the applicants. Loss of profit calculation for the balance of the contract. Federal Court

Loss of alternative investment opportunities. Calculating the loss suffered by the applicant as a result of a failed property investment, based on property valuation advice provided by the respondent. Federal Court.

Theft of intellectual property. Calculating the loss of profit to the business as a result of employees allegedly stealing intellectual property and setting up in competition.

Theft of inventory. Calculating the loss of profit as a result of allegations of misappropriation of stock by a manager in a supermarket.

Breach of contract – loss of a seat on a board. Calculating the value attributable to a seat on the board associated with a minority interest in a public company. Analysis based on comparable public transactions.

Breach of contract. Calculating the lost profits to the mobile phone incumbent as a result of the government’s proposed deregulation of the market and the introduction of competition.

Personal injury claim. The plaintiff suffered an injury at work. Reviewed the settlement offer and tested the assumptions of the offer.

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Valuing Economic Damages

Valuing Economic Damages

This article explores issues addressed by the expert in an economic damages claim. Click here for further forensic accounting articles

In a damages claim which is the appropriate measurement? Lost profit or lost business value? What is the difference and how are they calculated?

Lost profits calculations are often used when the business or part of the business continues, but the business suffers a reduction in earnings. The damages are calculated for the period up until the business is restored to the position it would have been if the alleged damaging act hadn’t occurred.

Lost business value tends to apply where a business or part of a business ceases permanently as a result of the alleged act. The value of a business is the current, net present value of an earnings stream in perpetuity or for the life of the business.

So, the key difference between a loss of profit calculation and a loss of business value is the period. Whether the earnings were damaged for a limited specific period (loss of profits calculation) or earnings are damaged for the life of the business (loss of value calculation).

That does not mean that the methods are mutually exclusive. There could be an instance where the plaintiff continued struggling with the business (loss of profits) but the business eventually folded (loss of business value).

Care needs to take though not to double count. In theory, the present value of any claim of lost profits cannot exceed the value of the business at the date of the loss.

In both calculations, the two key pieces of information requiring judgement by the expert are the earnings base and the discount rate. The discount rate and earnings base may be different in a loss of profit calculation to a loss of business value calculation.

Approaches for calculating the earnings base, include:

  • comparing the plaintiff’s earnings before and after the damaging act, or
  • comparing the plaintiff’s earnings after the damaging act to a comparable company or benchmark

Assumptions need to be made about what direction the earnings would have taken, but for the act. Were earnings prior to the act trending up or down?

Were there any other factors, apart from the act, that would have impacted earnings after the act? For example, was there a change in the industry, was there more or less competition, slower or faster economic growth? Was anything done by the plaintiff to mitigate losses?

Consideration also needs to be given to the period of trading prior to the act. How long had the business been trading? How well established and consistent were the earnings prior to the act?

With regards to the discount factor needs to reflect the risk of the earnings. Evidence for relevant discount factors might include comparable company information and comparable transactions. The discount factor needs to be relevant to the earnings base.

Simon Cook

Simon specialises in providing valuation and economic damage reporting services in disputes. Prior to founding Lotus Amity, he was a Forensic Accounting and Corporate Finance partner with BDO Australia and led their National Forensics practice. He has worked as a forensic director for a major offshore forensic accounting practice which included assisting in multi-billion-dollar litigation in relation to the largest Bernie Madoff feeder fund. He has also held senior management positions with Deloitte and Crowe Horwath