Rate & Flow
An Overview of an Alternative Approach to Determining Active/Passive Appreciation in Marital Dissolutions
In this summary article, we present an overview of a complex and detailed valuation model. To download your complimentary e-book containing of the full text of this discussion, please see www.mercercapital.com.
This model is presented in conjunction with a discounted cash flow analysis. Slight changes in the approach, along with the application of common sense, make this model applicable to the single period capitalization method and the guideline company method (both of which receive a fuller treatment in the foundational article), but we present only the discounted cash flow analysis here. In states where an owner/spouse's active management of a business does not preclude the consideration of passive appreciation, the following model offers a fresh approach based on rate and flow analysis.
The basic premise: Under certain circumstances, you can calculate active/passive appreciation by starting with the valuation date-which is presumably the date of separation, although in some states it may be the date the divorce action began. Then by "dialing back" the various components of value (discount rate and cash flows) to the date of the marriage, you can isolate the respective contributors to appreciation in value.
This model applies rate-volume analysis to the appreciation of the value of an enterprise to separate
"exogenous" and "endogenous" contributors to the change in value. Exogenous events have a direct impact on appreciation, but are beyond the control of the company's management-such as a decline in the interest rate environment. Endogenous events are those events driven by management that contribute to appreciation. Our model seeks first to identify the former, reaching the latter as the residual or remainder.
The model examines the internal/external factors in a simple, reasonable way. It's based on a primary rule of finance: that the value of an enterprise is equal to a measure of cash flow (or earnings) times some multiple-the multiple reflecting the different growth expectations of investors as well as their required rates of return for various securities.