Cede & Co. v. Technicolor, Inc.

The motion picture film-processing company Technicolor, Inc. (defendant) was involved in a cash-out merger. Expert testimony from Professor Rappaport was introduced by Technicolor to explain the capital asset pricing model (CAPM) methodology used to estimate the fair value of Technicolor’s common stock. The CAPM involved combining the company’s cost of equity and debt to estimate the cost of capital. As part of the calculation, the market-risk premium was determined by using the coefficient beta to represent the volatility or risk associated with the stock. Typically, a higher beta represented a riskier or more volatile stock which, in turn, led to a higher cost of capital. Rappaport used a 1.7 beta based on the recommendation of Merrill Lynch. However, the 1.7 beta was recommended right after the merger announcement. The following month, Merrill Lynch recommended a 1.27 beta, after the volatility had calmed down. In Rappaport’s testimony, he also explained that he modified the cost of capital calculation by including a 4 percent premium on the original CAPM calculation because of the small-capitalization effect. The small-capitalization effect involved imposing a premium over the CAPM computation for smaller companies based on a recognition that the CAPM estimates a slightly lower cost of equity for smaller companies. Following the calculations, Rappaport found that the cost of capital was 20.4 percent for all of Technicolor’s divisions except for three divisions that had a different cash flow. For the other three divisions, the cost of capital was 17.3 percent. Expert testimony from Torkelsen was also introduced. Torkelsen explained that he formed a different calculation based on using a range of discount rates. The expert testimony was then evaluated in an appraisal proceeding in the Delaware Court of Chancery.