iii) The particular facts of this case makes such an approach one which the Court can accept, being:
· A limited life of the business (17 years and 13 years).
· Almost guaranteed cash flows. As 60% from this Company and 40% from known external suppliers (on Contract).
· Expenses are fairly minimal and predictable.
· The provision of the air space is guaranteed as per the agreement with Austral and their need for the extraction of clay to continue their own brickworks business.
· Discount rate has been fully explained and deemed to be appropriate by Mr Lonergan.
85 Moreover the applicant emphasises that the respondent has not produced its own assessment based on the DCF method but has confined its case to a criticism of the DCF rate applied by the applicant's expert. Furthermore there is an advantage arising from the absence of either a complicating factor of betterment or discount be applied to the value of the airspace.
86 The principal witnesses relied upon by the applicant are Mr Don Reed and Mr Wayne Lonergan. Mr Lonergan co-opted assistance from an associate, Mr Martin Holt. The respondent relies solely upon the evidence of Mr Preston for its attack on the applicant's DCF analysis.
87 Mr Reed is a qualified geologist and has 31 years experience in the quarry industry and 16 years experience in the landfill industry in Australia and overseas. The methodology adopted by Mr Reed is to calculate the difference between:-
(i) the net present value (NPV) of the projected operational cash flow of the landfill operation at Horsley Park assuming that no land had been resumed and that the total airspace originally available could have been landfilled; and
(ii) the NPV of the projected operational cash flow of the landfill operation at Horsley Park after resumption (and consequent sterilisation) of part of the Horsley Park airspace, by the RTA, on 28th May 2004.
88 Mr Reed made assumptions in relation to:-
· development approval for quarrying and landfill operations;
· extraction and landfill scheduling;
· handover of quarried airspace by Austral to Collex;
· landfill compaction and landfill densities;
· types of fill able to be placed in the Horsley Park landfill;
· landfill forecasts (tonnes per anum);
· tip fees for landfill, before and after EPA levy;
· landfill revenue;
· operational costs - labour, operating, maintenance and fuel;
· administration costs -royalties, provisions, other, premises and general overheads;
· fixed costs - depreciation, insurance, rates and taxes etc;
· capital expenditure - pre-payment, establishment etc;
· discounted cash flows - discount rates;
· risk and sensitivity analyses.
89 He adopted a "before tax" discount factor of 12% on the basis of experience with similar valuations over the last five years. However he relies on the opinion of Mr Lonergan in relation to the appropriate discount rate to apply to the "after tax" cash flows. Mr Lonergan adopted a weighted average cost of capital in the range of 8.41% to 8.74% after tax reflecting his opinion of the appropriate discount rate to apply to the landfill operation at Horsley Park. If required to apply a single discount rate Mr Lonergan would choose the mid point of the range after tax namely 8.58%. Mr Reed rounded the discount figures determined by Mr Lonergan to a mid point of 8.6%.
90 In a written joint statement Mr Lonergan and Mr Holt express the opinion that the methodology adopted by Mr Reed is a widely used and accepted valuation methodology and is the appropriate methodology to use in assessing the loss caused by the resumption. Furthermore the DCF approach is the most theoretically sound valuation methodology where reliable financial information about future events is available. The concept of discounting is based upon the principle that the value of the sum of money received in the future is less than the value of the same sum of money if it were to be received today. The difference in value between money receivable today and receivable in the future arises for a number of reasons which include inflation, interest, and risk.
91 According to Messrs Lonergan and Holt the DCF approach comprises the following four steps:-
(a) Estimate future cash flows for the forecast period of operations.
(b) Discount these cash flows to a present value at a rate of return that considers the relative risk of achieving the cash flows and the time value of money.
(c) Estimate the residual value of any assets subsequent to the period of operations.
(d) Combine the present value of the residual assets with the projected cash flows operations to indicate the fair market value.
92 They explain that the relative risk of a specific business compared to the investment risk in businesses generally is reflected in the capital asset pricing model (CAPM), as the beta. For example, risk-free assets such as government bonds have a beta of 0, whereas a diversified portfolio of companies has the same risk as the market generally, that is, a beta of 1. More risky companies have higher betas and conversely less risky companies have lower betas. A beta of 1.0 to 1.1 has been adopted by Messrs Lonergan and Holt as appropriate in the circumstances, after considering the betas of companies carrying on comparable or related activities to the Horsley Park operations of Collex, and broadly Austral. Assuming a beta of 1 they have assessed the cost of equity as 11.85% whereas with a beta of 1.1 the cost is 12.45%. These numbers are consistent with the figure of 12% adopted by Mr Reed.
93 Acknowledging that the DCF methodology becomes more challenging if the period over which projections are made is extended beyond five or ten years Mr Holt nevertheless told Dr Griffiths in cross-examination that he was confident of its relevance in the present case where there is a significant degree of consistency about the operations of the business.
94 In his oral evidence Mr Lonergan explained the difference between a discount rate and an internal rate of return. The former is used to calculate the value of an asset as Mr Reed has done whereas the latter is an internal calculation that is specific to an individual company and takes into account not just the inherent cash flows of the business but other internal matters that are company specific. The discount rate is market driven and results in a market value whereas an internal rate of return is an internal calculation which takes account of other factors that the market cannot recognise.
95 Mr Lonergan confirmed that, in his view, Mr Reed appropriately applied the DCF methodology subject to the assumption by Mr Reed that operational cash flows arise at the end of each accounting period. Mr Lonergan's opinion is that the appropriate treatment is to make an assumption that the cash flows arise (on average) at the mid point of each accounting period reflecting the fact that the cash flows occur over the accounting period rather than at the end of each financial year. Mr Lonergan recalculated the net present value of the operational cash flows adopting a pre-tax discount rate of 12% per annum to disclose a loss of $4,887,000.00, which contrasts with the result achieved by Mr Reed of $4,545,000.00.
96 As a matter of both logic and market behaviour Mr Lonergan prefers to use a post tax discount figure for the purposes of a CAPM. He explained to Dr Griffiths in cross-examination that all the market participants, regulators investors and companies work on an after tax basis both as a model and because all the reference data across a spectrum of investment opportunities to calculate a scientific observable number are expressed in after tax terms. If the after tax discount rate is grossed up at the standard rate of tax in order to ascertain the pre tax factor, it will not work in all circumstances and in some circumstances will give a higher value whereas in others it will give a lower value. As indicated earlier operational cash flows have been prepared by Mr Reed on the before tax basis but the preferred approach by Mr Lonergan in the current situation is to determine the net present value of future cash flows on an after tax basis and to "gross-up" the assessed value for tax. He says that the adoption of pre-tax flows and a pre-tax discount rate is likely to produce a lower value.
97 Mr Lonergan and Mr Holt expressed a disclaimer in their joint statement of evidence as follows:-
6. We in no way guarantee the achievability of the budgets or forecasts of future cash flows. Budgets and forecasts are inherently uncertain. They are predictions by management of future events which cannot be assured and are necessarily based on assumptions of future events, many of which are beyond the control of management. Actual results may vary significantly from forecasts and budgets.
7. We have assumed that these budgets and forecasts have been prepared fairly and honestly based on the information available to management at the time and within the practical constraints and limitations of such budgets and forecasts. We have assumed that the budgets and forecasts do not reflect any material bias, either positive or negative. We have no reason to believe that these assumptions are inappropriate.
98 However, Mr Lonergan explained in cross-examination that Mr Reed had adopted the best estimate and that this was an acceptable thing to do in the present case where there is a fairly low risk. In other words what is a prima facie reasonable forecast should be relatively symmetric in the present "fairly low risk" case. Mr Lonergan describes the business of Collex as a low risk business with a bit of moderate risk for pricing. It is basically low risk. Therefore, the type of business implies a beta of less than 1. Accordingly having regard to the landfill operations in particular and to the betas for other companies identified by Mr Lonergan in general he considers a beta of 1.0 to 1.1 is appropriate. He acknowledges that there is a degree of judgement in forming a view as to an appropriate beta. He was not persuaded to alter that judgement notwithstanding an extensive cross-examination. A beta of between 1 and 1.1 in respect of the Collex business at the subject site reflects the relative risk in the investment to the market as a whole and has regard to the risk calculation carried out by Mr Reed, as well as Mr Lonergan's own review of it given his knowledge of market risk in general and the statistical backup from the contemporaneous market.
99 Generally speaking the evidence of Mr Holt corroborates and provides a basis for the evidence of Mr Lonergan. However, in his oral evidence Mr Holt makes some specific observations in respect of a transaction used by Mr Preston. The transaction is the purchase (through a shares acquisition by Collex) of a property at Riverstone for the purpose of a waste facility. Mr Preston developed a rate of return of 21.7% based on an analysis of that transaction. Mr Holt does not agree that such a discount rate, established by reference to an internal rate of return, should be adopted. However if some reliance is to be placed on that sale it is his opinion that it should properly reflect the rate of return implicit in the transaction namely the cash flows that the vendors sold and that Collex as the purchaser acquired. According to Mr Holt the cash flows show a return of 15.7%. Therefore, if any reliance is to be placed on the transaction the market rate of return of 15.7% should be adopted. Further as the transaction took place in 1999, (5 years prior to the resumption) an allowance should be made for movements in the market value of business and equity values in that intervening period.
100 Mr Lonergan estimates that the internal rate of return calculated by Mr Preston in respect of the Riverstone property would be reflected in a beta of 3.2. In colloquial terms he says, "that's off the planet. It is so high as to be clearly and manifestly extremely wrong".
101 When asked in cross-examination, why (given the confined market of potential purchasers for the Riverstone site) the valuer determining a discount rate or internal rate of return for the Riverstone site would not refer to the projection of Collex as the purchaser, thereby reflecting its expected ability to grow the business, Mr Holt said:-
I think what you continue to confuse is the transaction that was in the market between the buyer and a seller, were the cash flows that the vendor offered for sale and the cash flows that the purchaser bought. The cash flows that the purchaser subsequently generated are an entirely different matter, those were not the cash flows that were offered to the market in a transaction. So there is no market reference point on those transactions, the only market reference point is what the vendor sold and what the purchaser bought, and that's a long established tradition. (transcript p 41 20/07/06).
102 Mr Reed established the projected loss in earnings as a consequence of a 15% reduction in landfill capacity at the subject site by calculating the variation in the net present value of discounted cash flows prepared for "the before and after case". Using a before tax discount factor of 12% on the basis of industry experience, and after extensive consultation with Mr Lonergan and Mr Holt, he calculated the present value of the variation in earnings as a direct result of the land resumption at $4,544,889.00. After noting adjustment made by Mr Lonergan, Mr Reed expressed the opinion that the derived value of $4,887,000.00 represents the price that an informed and willing but not anxious buyer would have paid at the time of resumption for the loss of 1.02 million m3 of airspace approved for solid waste landfill. He states that the methodology used to determined the net present value of landfill airspace is essentially the same as that applied by his firm in valuing quarry and landfill businesses for a range of clients including state and local government authorities, accounting companies, major banks and some merchant banks.
103 Although Mr Reed relies on five and ten year forecasts for projections to a period beyond ten years, he explains that by the time ten years is reached the impact on the bottom line is much less, so that by the time twenty years is forecast the discount factor basically takes the cash flow out altogether. Unexpected volatility in recurrent costs such as fuel costs do not affect the valuation to any significant extent because the margin for the operation remains constant in the before and after situation.
104 Following an adjustment to the final estimate of the loss of airspace upon receipt of further evidence from the surveyors, Mr Reed adjusted his value of the lost airspace to $4,918,000.00. However, the applicant's DCF claim is based on Mr Lonergan's figure of $4,887,000.00. This amount is confirmed in the final points of claim and final submissions on behalf of the applicant. Notwithstanding the further evidence of Mr Reed that his final calculation is $4,918,000 based on the whole of the evidence made available to him it is appropriate for compensation payable to be assessed against the amount for which the applicant contends relying on the evidence of Mr Lonergan. The further evidence of Mr Reed merely confirms that the amount claimed is justified. I propose to adopt the figure derived from the DCF calculation as $4,887,000.00
105 Primarily Mr Preston believes that the subject land can be valued readily by the comparable sales evidence. In his opinion the DCF methodology is, at best, a possible check method. In his original report Mr Preston criticises a number of specific matters and assumptions that were adopted by Mr Reed for the purpose of his analysis. He does not disagree with the approach taken by Mr Lonergan for the purpose of calculating a discount rate. However, he disagrees with the practical application of that discount rate relevant to comparable sales and in particular the sale of the Riverstone property to Collex. Moreover, he would prefer to look at discount rates applicable to transactions involving private companies owned principally by individuals rather than by developing a rate referable to the activities of public companies. He doubts that the former would adopt the same sophisticated approach as the latter. It is his expectation that the former would offer a price per cubic metre of airspace based on the perception of the market place.
106 Mr Holt recalculated the Riverstone figures by excluding depreciation as a component of the cash flow. The recalculation showed a rate of 21.9%. He makes the distinction between the 15.7% figure representing the market rate of return from the transaction and the figure of 21.9%, which he says is a market rate of return from the business at the site. The greater rate of return used by Mr Preston reflects the fact that Collex already owned the business for which it was going to use the site, and therefore it would not expect to pay a second time for cash flows that it already owned.
107 Mr Holt also pointed out that since the tax rate was set at 30% he had not observed a pre-tax discount figure higher than 15%. Mr Reed commented that 12% has been a figure, (plus or minus a percentage point), used in projects of comparable size in comparable industries for quite some years. Both Mr Reed and Mr Lonergan point to the difficulty in identifying two directly comparable sites in the quarrying and landfill industries as a consequence of the number of variables that apply. Mr Reed says, recognising that difficulty, the industry relies on the DCF analysis.
108 Mr Preston agrees that the DCF method is one of the best methods to value a business. The major issue he raises is in regard to the discount rate. For his analysis he relies primarily on the Riverstone sale. He agrees that the best method of assessing the loss by Collex is to use a before and after method on a discounted cash flow approach combined with a comparable sales approach. He accepts that where a particular owner can achieve a greater return from particular premises the additional return could increase the value to the owner. In the case of the Riverstone sale Mr Preston accepts that if the internal rate of return calculated at 21.9% is an indication of the return expected by Collex by reason of its own advantages and techniques in the waste disposal and landfill business, then, the true internal rate of return would be 15.7%.
Special Value
109 On the assumption that the value of the lost airspace is greater than the market value of the acquired land the applicant submits that the difference is "special value" for the purposes of the Just Terms Act. Special value is defined in s 57 as:-
The financial value of any advantage, in addition to market value, to the person entitled to compensation which is incidental to the person's use of the land.
110 The applicant's argument is difficult to follow in the context of the observation by Mahoney JA in Yates Property Corporation Pty Ltd (In Liquidation) v Darling Harbour Authority (1991) 24 NSWLR 156 at 162 D as follows:-
Special value can only arise where, at the time of compulsory acquisition, the owner is actually putting the property to some use for which it is especially well suited. It is a term of art used to describe a characteristic of the expropriated interest which is of economic value to the owner but which would not enhance the market value of the interest and hence would not be included in the "market value" component as the compensation to which the statute entitles the owner following resumption: see discussion in Todd (at 105ff); see, also, Gagetown Lumber Co Ltd v The Queen [1957] SCR 44 at 62; 6 DLR (2d) 657 at 671.
111 The evidence establishes a value for the lost airspace as part of the value of the land for the very purpose for which it would be offered for sale to any purchaser seeking to use if for that highest and best use albeit not active at the date of resumption. The other component is a remainderman's interest, which together with the value of the airspace reflects both elements of the actual value of the land. It is not necessary in my view to introduce a distinct figure to accommodate the concept of special value in this case.
Market Value and Injurious Affection
112 Mr Reed asserts that the value derived using DCF represents the price that a willing but not anxious buyer would have paid at the time of the land resumption for the affected airspace approved for the solid waste landfill and accessible for that purpose after end June 2017. Representing, as it does the NPV of the projected operational cash flow in the before and after situation no account is taken of the residual value of the land after landfill is completed. This fact is relevant in respect of the valuation of the acquired land. It has been separately valued as a remainderman's interest and must therefore be added to the value of the lost airspace to determine the just entitlement to compensation. Not only is the airspace of economic value to the dispossessed owner, Collex, it would be included in the general market value component of the acquired land.
113 After giving due consideration to the various criticisms raised by Mr Preston and appreciating the reluctance demonstrated by courts to accept the DCF methodology I nonetheless propose to adopt the overall joint opinions and advice given by the applicant's witnesses in the circumstances of this case where there is a significant degree of consistency about the operation of what is essentially a low risk business. I adopt the DCF method as the primary method of valuation. That approach carries with it the advantage of eliminating the relevance of a number of possible variables and adjustments such as a betterment factor or possible deferral of the price of the airspace as these matters are taken into account by the DCF calculation. The comparable sales analysis provides considerable assistance as a check method to show a result relevantly consistent with the DCF outcome.
114 Taking into account all of the evidence I determine the amount of compensation to which Collex is entitled pursuant to s 54 and s 55 (a) and (f) of the Just Terms Act as follows:-
Present value of the land acquired
assuming completion of the landfill: $1,997,798.00
Value of lost airspace in Lots 8 and 9: $4,887,000.00
Total: $6,884,798.00