Simultaneous determination of market value and risk premium in the valuation of firms
Valuing a firm using the discounted cash flow method (DCF) requires the joint determination of the market value of its equity (MVE) together with the equity risk premium (ERP) the firm should earn, since the latter is part of the discount rate used in the calculation of the MVE. This paper presents a theoretical derivation of how MVE and ERP can be calculated simultaneously under fairly general conditions. Besides firm data on free cash flow to equity the only external data needed are the risk-free rate of interest and a parameter indicating the required market risk premium per return volatility.
|Date of creation:||2012|
|Date of revision:||Oct 2012|
|Note:||The views expressed in this paper are those of the author and do not necessarily reflect those of the institutions he is affiliated with. Any information presented is of a general nature and does not address individual circumstances of any particular person or entity. The author would like to thank Nils Holinski for helpful comments and suggestions as well as Nitish Maini and Keshav Goel for diligent research assistance; the usual disclaimer applies. Financial support by the International Centre for Economic Research (ICER), Torino, Italy, and by the Spanish Ministry of Education and Science (Grant No. ECO2008-06191) is gratefully acknowledged.|
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