Rick Warner, the intrepid editor of the ASA's Business Valuation E-letter, alerted his readers this morning to an article from Roger Grabowski in the Business Valuation Review coming out soon. Rick's analysis:
Roger Grabowski, ASA provided me with a draft of an article that is scheduled to appear in an upcoming issue of Business Valuation Review. The article itself is an excerpt from discussions that appear in Chapters 7 and 9 of Cost of Capital: Applications and Examples 4th ed., by Shannon P. Pratt and Roger J. Grabowski (John Wiley & Sons, Inc., 2010) with an update through December 2010.
The article discusses the development of a cost of capital, in particular the choice of a risk-free rate of return and the estimation of a forward-looking equity risk premium during times of economic turmoil. Roger focuses on the period from late 2008 and 2009, and also the summer of 2010 as periods characterized by a “flight to quality” by investors.
Roger’s discussion of the choice of a risk-free rate of return and the estimation of an equity risk premium covers concepts that are probably familiar to many of us, however it is a good review and in particular does a great job of discussing investor expectations and the relationship (if any) with realized risk premiums.
One new discussion point that I was not aware of that Roger introduces is the possibility of a WWII interest rate bias that has the effect of raising historical, realized equity risk premiums by perhaps as much as 50 basis points.
If you are looking for a concise discussion of these and other cost of capital concepts including an update on the expected equity risk premium as f December 31, 2010, keep your eyes open for this upcoming article, again in the Business Valuation Review.