Cost of Capital: Applications and Examples, + Website, 5th Edition

APPENDIX 19A

Examples Using the Duff & Phelps Risk Premium Report Data¹

James P. Harrington

Using the Risk Premium Report

Inputs

Guideline Portfolio Method versus Regression Equation Method

ERP Adjustment

Using the Size Study— Examples

Using the “C” Exhibits—Examples

Closing Thoughts on Using the “C” Exhibits

Using the High-Financial-Risk Exhibits

Using the High-Financial-Risk Exhibits in the Build-up Method

Using the High-Financial-Risk Exhibits in the CAPM

Additional Information on Company Risk

USING THE RISK PREMIUM REPORT²

Before the analyst can use the Risk Premium Report (Report) data in estimating the cost of equity capital, he or she should understand the following:

• Choosing inputs when estimating the cost of equity capital and using the Report
• The difference between the “guideline portfolio method” and the “regression equation method”
• How to use the regression method when the subject company is small
• ERP adjustment, which is a necessary adjustment when using the build-up method

Inputs

When estimating the cost of equity capital using the Report, the user typically starts by making a few basic choices: a risk-free rate (R_f), an equity risk premium (ERP), and risk premium over CAPM from the “B” exhibits (i.e., size premium) (RP_s), or a risk premium over the risk-free rate from the “A” or the “D” exhibits (RP_m+s). Depending on the method selected to estimate cost of equity capital, the ERP adjustment may also have to be applied to account for the difference between the ...