Contents - AL-Tax

12.5 Analysis Under 2005 Proposed Cost-Sharing Regulations 175As noted, USP has claims to 50% of the separate JV companies’ free cash flows,supplies 50% of their equity capital requirements, makes additional in-kind contributionsto capital consisting of a portion of the JV companies’ intellectual property,and bears the associated risks. The JV companies’ free cash flows accruing toUSP (net of any interest costs on funds that they borrow directly from third parties)constitute USP’s total return on its equity investments therein. As such, these cashflows should yield the required return on investment of 12.78% on average. Applying31.0% to USP’s 50% share of the JV companies’ free cash flows, we obtainUSP’s hypothetical risk-free return on investment in these entities, expressed as apercentage of their free cash flows. This adjusted return is equal to 16.0% of totalfree cash flows (net of interest costs) generated by the JV companies (and shouldyield the risk-free rate of return on investment of 4.0% on average). In sum, if 50%of the JV companies’ free cash flows yields USP’s total required return of 12.78%,16.0% of the JV companies’ free cash flows yields the return that USP would requireif it bore no risks on its investment in these entities, all other things equal.USP should earn approximately the same risk-free rate of return vis-a-vis FS,expressed as a percentage of the latter’s free cash flows, all other things equal.However, FS was self-funding, developed and promoted USP’s marks in internationalmarkets at its own cost, and invested far more intensively in the marketingand promotion of its sites. As such, USP’s arm’s length return is less than 16.0%of FS’ free cash flows (net of interest costs). The adjustments necessary to reflectthese differences can be quantified using the same required return methodology.The aforementioned 16.0% of FS’ free cash flows should be reduced by half of itsequity capital, other than in-kind contributions, and multiplied by the risk-free rateof 4.0%.12.5 Analysis Under 2005 Proposed Cost-Sharing RegulationsConsider lastly our analysis of this case under the 2005 proposed cost-sharing regulations.For purposes of this analysis, we assume that USP and FS entered into acost-sharing agreement covering USP’s IT platform, in lieu of their joint ventureagreement. At this time, FS’ intellectual property consisted of intangible assets thatUSP acquired from one competitor in Europe and contributed to FS, certain of whichwere immediately retired (among them an IT platform). The remaining assets wouldnot have been contributed to the cost-sharing arrangement. USP had an establishedcommunity of users, the IT platform and a brand identity (known only in NorthAmerica).As described in Part I, the proposed cost-sharing regulations proscribe five methodsto select from in establishing the value of pre-existing intellectual propertycontributed to a cost-sharing arrangement: The CUT method, the acquisition pricemethod, the income method, the market capitalization method, and the residualprofit split method. We consider each of these methods in turn, other than the