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The Risk Premium Factor: A New Model for Understanding the Volatile Forces that Drive Stock Prices by Stephen D. Hassett

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Chapter 7

Valuing an Acquisition or Project

Risk Premium Factor (RPF) modeling principles can be applied to acquisition or project evaluation to overcome common pitfalls in valuation. The most important applications are in determining cost of capital and using the model to calculate terminal value. This also requires setting a reasonable time horizon. Whether it is a merger-and-acquisition (M&A) transaction or upgrading a piece of equipment, the same principles apply. The RPF Model removes debate about the equity risk premium (ERP). Setting the investment horizon (length of your forecast) is critical to valuing a company or project, especially when using the RPF Model to determine terminal value. The time horizon needs to be developed relative the growth and cyclicality of the business under evaluation. The terminal value captures the value of your forecast beyond the horizon. While typically accounting for a large share of total value, it rarely receives the same diligence as the forecast within the horizon. The RPF Model helps establish a reasonable terminal value consistent with market valuation.

Countless books and articles have been written on the subjects of mergers and acquisitions and valuation. These next few chapters will outline only the highest-level basics with the dual purpose of providing a high-level overview of how to value a company or project to those unfamiliar with the practice, along with providing those familiar or even expert in valuation, a deeper dive ...

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