Economic damages experts most often rely on three methods:
1) Before-and-After
2) Yardstick
3) Sales Projection.

Lost profits and diminished value

The purpose of economic damage calculations are to provide an opinion, in dollars, that will make the plaintiff “whole” again “but for” the defendant’s actions. Calculation of this amount rests upon numerous factors . Economic damage calculations may include lost profits, diminished business value, or both.

When experts calculate economic damages they most often rely on three primary methods:

  • Before-and-After Method

    Under the before-and-after method, the expert assumes that the company’s operating trends would have continued in pace with past performance and future expectations at the time of the defendant’s action. In other words, economic damages are equal to the difference between the present value of expected profits and actual profits. Alternatively, economic damages can be quantified as the difference between the company’s value before and after the defendant’s action.

  • Yardstick Method

    Under the yardstick method, the expert benchmarks a damaged company’s performance to external sources, such as similar publicly traded companies or industry guidelines. The presumption is that the company’s performance would have mimicked that of its competitors or industry if not for the defendant’s action.

  • Sales Projection Method

    Under the sales projection method, projections or forecasts of the company’s expected cash flow serve as a basis for damages. This method is often used for new businesses due to limited operating history and for niche companies due to limited comparable company or industry guideline information.

An expert considers the specific circumstances of each case to determine the appropriate economic damage calculation method (or methods) for the engagement.

Getting the final number

After experts have estimated lost profits, they discount these estimates to present value. Some jurisdictions have statutory discount rates, but more often experts will build up discount rates based on informed judgement and professional opinions about risk applicable to the subject company. In certain instances, small differences in discount rates can generate large differences in an experts’ final conclusion within an individual method. Therefore, it is prudent when possible to use multiple methods that are reconciled to avoid contention over this issue.

The final step in determining economic damages is to consider mitigation efforts by the plaintiff. Some jurisdictions expects plaintiffs to exercise their duty to mitigate economic damages and minimize potential losses.

Common pitfalls to avoid

Over and underestimating economic damages can be limited by considering a few key factors:

  • Considering taxation of award
    Taxation of damage awards can have a significant impact on an expert’s conclusion.If the plaintiff must pay taxes on the award, an after-tax assessment may result in an equitable conclusion. In addition, parts of damages awards, such as return of capital, may be nontaxable and require a separate after-tax estimate.

  • Matching cash flows to discount rates
    Taxes must also be considered when discounting lost profits to present value. Economic damages calculated on a pretax basis require the use of pretax discount rates. Mismatching after-tax discount rates to pretax cash flows will misstate damages, all else equal.

  • Determining the damage time period
    Economic damages should not always be assumed to occur into perpetuity. Economic damages generally occur over a finite time period, with defined beginning and end dates. Therefore, it is assumed that most plaintiffs can overcome the effects of the defendant’s actions at some point in the future.

  • Reviewing opposing expert reports
    If time and the engagement budget permits, allow your expert to review the opposing expert’s analyses or report. You may find out that the opposing expert did not take into account one or more of these key factors, or that your own expert did not consider potentially relevant factors that the opposition did.

Plaintiffs suffer economic damages for numerous reasons. An experienced economic damage professional can calculate and testify to your economic damages with confidence. An objective expert that is familiar with industry standard techniques can withstand an admissibility challenge and avoid potential pitfalls.
© 2017 (rev. 2020)

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