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Contents
SC&H Business Valuation & Support Leaders 
Michael J. Young, 
Nathan E. DiNatale,
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Valuations Insights, March, 2010 The Discounting Decisions That damages awards must be discounted to their present value, so that plaintiffs are not over-compensated, is not disputed. Discounting is a way of accounting for the time value of money (that a dollar today is worth more than a future dollar, because today's dollar can be invested and will add value over time) and risk (a bird in hand is worth more than two in the bush, as they say). Yet within the seemingly uncontroversial statements of the above paragraph are hidden substantial disagreements. Be sure your financial expert is aware of these differences and prepared to defend their methodologies. Two of the key controversial points are: what cash flow stream should be discounted, and what the appropriate discount rate is. Know the options so that you can intelligently assess your expert. Choosing a stream to discount. The following four common approaches depend on the particulars of the case: 1. Most likely cash flow. The analyst considers only a single "likely" future cash flow, generally ignoring the possible extremes of positive or negative results. This approach may fail to account for the possibility that conditions change, and it probably won't adequately characterize the range of possible outcomes. 2. Expected Cash Flow. This is the statistical average of all possible cash flow outcomes. The analysis required is complex and comprehensive, and requires the expert to make explicit assumptions about the future, which are then open to debate between experts. Some experts may baulk at the workload and the risk of being challenged. Consider whether you want an expert who shies away from this approach. 3. Single forecast analysis. Here is a variation on the "most likely" approach, as the expert, unable (or unwilling—again, consider your choice of expert) to construct the scenarios of the "expected" approach, instead weights the possible outcomes to arrive at one value. 4. Real options analysis. This approach accounts for the irreversibility of so many projects once undertaken and the uncertainty of circumstances often beyond the decision maker's control. How does a company determine when to invest versus how much uncertainty can be resolved by delaying such a decision? It is an approach with high information demands that necessitates sophisticated modeling. Choosing a discount rate. Three approaches dominate this choice. A good valuation expert will often use more than one to arrive at their conclusion.
The bottom line. The expert's role is to construct a well-reasoned analysis of the calculation of the profits (i.e., lost profits) a plaintiff would have yielded "but for" the defendant's actions.
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