The recent economic crisis should also prompt investors and financial managers to revise their views of the equity risk premium, say Stamos Nicholas and Greg Forsythe (both Deloitte), in their new white paper called “Are You Mispricing the Investment Risk?”:
Since the 2008 financial crisis … we have found that managers sometimes do not fully account for the dynamic and variable nature of equity risk premiums when estimating a cost of capital and evaluating potential investments. A common practice by some has been to solely rely on unadjusted historical ERP statistics or anecdotal support for a chosen ERP. Without appropriate analysis and inquiry, these practices can lead to an incorrect pricing of risk in prospective projects.
CFOs and others may want to reexamine how they typically value investments by “dispensing with the myth of the static ERP,” the authors conclude. They also cite the benefits of implied ERPs (versus historical estimates) and remind readers that “ERP varies by country markets.”
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