Opinion ID: 2604259
Heading Depth: 1
Heading Rank: 4

Heading: Forecasting the Amount of Future BenefitsIncome

Text: UP's expert was Dr. Arthur A. Schoenwald, a person with extensive credentials and long experience in the management and valuation of public utilities. The Tax Court was highly laudatory of the articulateness and sophistication of his presentation. Schoenwald presented an income approach to value commonly referred to as the yield capitalization approach. Ideally, yield capitalization methodology would project net cash flows that could be expected from an asset for each future period (the usual period being a year, for tax purposes). Thereafter, as will be discussed more fully in a later section of this opinion, net cash flows would then be discounted in order to arrive at a present value, i.e., what one would be willing to pay at a particular moment for the right to receive the projected income stream at the time or times in the future when it would be earned. The discounting would be accomplished by dividing the projected cash flows by a figure known as the discount rate, a figure that reflects both the time value of money and the relative risk to a potential investor that may be associated with that particular asset. Schoenwald's approach was to evaluate the characteristics of the assets that he was appraising to determine a normalized net cash flow that could be projected into the future. Next, he evaluated whether those net cash flows could be expected to grow in the future, i.e., to go up in ways that would increase the present value of the assets. This is what Schoenwald meant by growth, and it is different from a mere increase in the amount of income. Schoenwald recognized that, given traditional inflationary pressures, UP's prices might go up and, therefore, its gross receipts from its railroad activities might go up correspondingly. That would not, however, be growth in the sense that a potential investor would be looking for growth, because it would not necessarily represent an increase in the value of the underlying asset base that was producing the income stream. The difference between growth and no growth is significant to the valuation process. In algebraic terms, value may be represented by V, net cash flows by NCF, and the discount rate by k. If no growth is expected, the discounted value of the assets when there are net cash flows can be expressed by the simple formula NCF V = [5] . ---- k If, on the other hand, growth is to be expected, the formula becomes much more complicated algebraically. The Department states the growth formula this way: Because of the significance of the presence or absence of growth, Schoenwald first focused on whether there would be growth in net cash flows.