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August 09, 2010
Brattle Consultants Co-Author Article on the Use of Multiple Discount Rates in Damage Calculations for the Journal of Business Valuation and Economic Loss Analysis

Brattle principal Frank Graves and senior consultant Bin Zhou, along with attorneys Melvin Brosterman and Quinlan Murphy of Stroock & Stroock & Lavan LLP, authored an article on risk-adjusted damages for the Journal of Business Valuation and Economic Loss Analysis. In the article, “Risk-Adjusted Damages Calculation in Breach of Contract Disputes: A Case Study,” the authors discuss a breach of contract arbitration in which the need for two distinct discount rates to calculate damages was the cornerstone issue, not just a mere refinement to the valuation of damages. The case described in the article appears to be the first of its kind as a legal precedent in which different discount rates were used to value the lost versus replacement cash flows due to their significantly different levels of risk. A low rate was applied to determine the present value of the relatively safe revenues that were lost from the breached contract and another higher rate was used to value the poorer quality revenues available in the breach world. The authors review the economic and legal principles particular to this case, including risk-adjusted valuation, the capital asset pricing model, and the net present value rule, and illustrate how they were successfully used in this dispute. They conclude that the importance of this case is its legal validation of an important, well-established principle in financial economics – that the appropriate discount rate for valuation of damages should reflect the underlying market risk of the expected cash flows, which may differ before and after a breach of contract. To read the full article, please visit the Journal of Business Valuation and Economic Loss Analysis website.