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Home  /  Insight & News  /  Increased Equity Risk Premium Recommendation Reaffirmed in Consideration of Impact of COVID-19 on Businesses

Increased Equity Risk Premium Recommendation Reaffirmed in Consideration of Impact of COVID-19 on Businesses

  • October, 2020

In March 2020 Duff & Phelps increased its recommended U.S. Equity Risk Premium (ERP) from 5.0% to 6.0%,. The ERP is used in the development of a discount rate, to account for current economic and financial conditions and risks; these notably include factors such as COVID-19 and related effects on businesses and investments. At that time Duff & Phelps maintained its then-current recommendation of a 3.0% Normalized U.S. Risk-Free Rate (to be used in combination with the ERP), reflective of the interest rate environment at that time.

In its March announcement of the increase in the ERP, Duff & Phelps pointed to changes in real GDP growth and forecasts, unemployment, business confidence, U.S. corporate credit spreads, and implied equity volatility as considerations contributing to the increase in the recommended ERP.

Subsequently, in early July 2020, Duff & Phelps lowered its recommended Normalized U.S. Risk-Free Rate to 2.5%, reflecting decreases in interest rates; the ERP was reaffirmed at 6.0% at that time. As of mid-September, both the ERP and the Normalized U.S. Risk-Free Rate had been reaffirmed at the July-2020-recommended rates. At that time, factors to which Duff & Phelps pointed supporting these recommendations included negative U.S. GDP growth and an increase in market volatility, as well as changes in credit spreads, unemployment rates, and consumer sentiment.

The risk-free rate and the ERP are two important components in discount rates estimated using approaches such as the Build-Up Method and the Capital Assets Pricing Model. The effect of an increase in the discount rate, all else equal, is to decrease the value of a subject company being appraised or a stream of income (e.g., in a lost profits damages calculation).

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