Company-specific risk premium gets thepopular vote

BVWireIssue #122-1
November 7, 2012

As the BVWire goes to press, the outcome of the presidential election is still highly unsettled, with the candidates locked in a statistical tie. One thing is for certain: If either party wins the executive office—or either legislative house—by two-thirds of the vote, we’ll be hearing words such as “landslide,” “supermajority,” and “mandate.”

So why then, when well over two-thirds (71%) of appraisers who responded to our recent online survey say they typically add a company-specific risk premium to calculate the cost of capital in their modified CAPM/DCF analyses, do they still consider the issue far from settled? “It depends,” according to one representative comment. “I do apply a CSRP” when the subject company is small (only one owner) and the pool of potential buyers does not own multiple investments. But even “small businesses” can generate tens of millions in revenues and strong cash flows, attracting more professional investors. “If that is the case, I will lower or eliminate a CRSP.”

Another respondent notes that for larger companies, the market has already priced specific risk factors. Still another suggests replacing the current terminology with “an adjustment for lack of diversification" or an "adjustment for differences from comparison set."

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