Valuation in Light of Uncertainty : How Stock Option Pricing Models Can Inform More Accurate Valuation Discounts for Built-In Gains

What is the value of a closely-held corporation that does not engage in ongoing service activities but owns $100 million worth of assets that it initially purchased for $20 million? When a corporation does not engage in ongoing service activities but owns property, its value depends on the value of its property. Accordingly, some might say that the corporation is worth $100 million since it could sell its assets for $100 million and liquidate. Others might say that the corporation is worth $72 million since it could sell its assets for $100 million but would be required to pay a $28 million tax bill (representing a 35% tax rate applied to the $80 million built-in gain it would recognize upon sale of its assets) before liquidating. Courts and scholars have come to both conclusions, most recently favoring the latter. However, a rational purchaser would not buy the corporation for $100 million and a rational owner would not sell it for $72 million. The value of the corporation falls between these amounts. This is because, in addition to the option of selling its appreciated assets immediately, the corporation also has the option of selling its assets in five, ten, or more years. By delaying the sale of the appreciated assets, the corporation delays incurring tax and, in present value terms, pays less tax. This Article proposes a new valuation method to calculate the present value of a future tax liability when it is uncertain when that future tax liability will be incurred. Instead of ignoring uncertainties about when a tax liability will be incurred and what tax rate will apply at the time it is incurred, this method accounts for these uncertainties by using weighted probabilities of multiple likely outcomes. This Article's key insight is to adapt the binomial method (a stock option valuation technique that accounts for similar uncertainties) to this problem