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Valuation & Equity Market Risk Premium (CAPM)

Blog: Valuation & Equity Market Risk Premium (CAPM)


From June until August 2019 I have written 6 blogs on business valuation and financial modelling in order to calculate enterprise value. These blogs are still available, you can find the links of the blogs at the very end of this blog.


In the upcoming months, I will write several blogs on the so called “Cost of Capital” that is used in business valuation.


I got inspired to do this after reading the book: “The real cost of capital: A business field guide to better financial decisions” (2004). The book is written by Tim Ogier & John Rugman & Lucinda Spicer.


And in this sequence of blogs on the “cost of capital” I will share the main findings of the book. By the way, the book is very good, really recommend to read it for every finance professional!


The Cost of Capital is critical to understand for any finance professional and in the first blog of this sequence I have talked about the “risk free rate” and “betas”. You can find this blog of 24th October 2019 here:


In this second blog I will talk about the: Equity Market Risk Premium (EMRP).


Consultant & Trainer: Joris Kersten


I am an independent M&A consultant and Valuator from The Netherlands. In addition, I provide training in “Financial Modelling”, “Business Valuation” and “Mergers & Acquisitions” all over the world. This at (investment) banks, corporates and universities.


And I provide open training programs in my home country The Netherlands:

-Business Valuation & Deal Structuring (6 day training);

-Financial Modelling in Excel (4 day training).


At the very end of this blog you can find all information about my open training programs.


Introduction to the Equity Market Risk Premium (EMRP)


The Equity Market Risk Premium (EMRP) is the most significant number in cost of capital analysis.


The EMRP is the additional expected return that an investor demands for putting his or her money into equities of average risk, rather than a risk free instrument. The formula is:


EMRP = The expected return on a fully diversified market portfolio of securities – (minus) the expected return on a risk-free security proxied by the return on a government bond.


The EMRP can be calculated based on a:

-Historic approach;

-Forward looking approach.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Historic approach to determine EMRP


The most used method to determine the EMRP is the “historic approach”. And within this method the EMRP can be calculated with “Arithmetic means” versus “Geometric means”.


Historic returns achieved by a diversified market portfolio of equities are best proxied by the returns achieved from the stock market itself. And historic returns on government bonds (risk free rate) can then be subtracted to give an estimate for the EMRP.


And now is the question how these historic returns should be calculated. It can be done with arithmetic means or geometric means, and the resulting EMRP will differ depending on the type of mean that is adopted.


Arithmetic means suggest higher historic EMRPs than geometric means. This is because an arithmetic mean simply averages the individual annual returns over the period considered. But geometric means calculate the annual compound growth over the period.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Historic estimates of the EMRP


The historic EMRP also depends on the number of past years over which it has been calculated. This can result in a big variation in the level of the EMRP itself.


In the US, data going back to 1926 published by “Ibbotson” is widely used. Here they come up with a EMRP of 5.8% (geometric).


Within this respect it is interesting to note that when looking at the period 1926-1961 and 1962-1997 the EMRP is respectively 7,6% and 4.0% (both geometric). This means that the EMRP is going down.


Explanations could be that:


-From 1962-1997 stock markets were relatively stable and bond markets relatively unstable. This would lead to an increase in fixed income returns (bonds) which brings the EMRP down;

-From 1962-1997 a substantial increase in pension funds and other long term investors came to the market. And an increase in supply of capital leads to a reduction in the EMRP (ceteris paribus).

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Forward looking approaches: Bottom up model


Forward looking approaches estimate the EMRP on the basis of market forecasts rather than historic returns. Here for are two basic techniques: bottom up studies and top down reviews.


Bottom up models typically work by projecting future company dividends. And then the internal rate of return (IRR) is calculated that sets out the current market capitalization equal to the present value of the future expected dividends. (I will discuss this “dividend discount model” later in this sequence of blogs on the “cost of capital”)


And a similar procedure can be applied to all companies in aggregate, in order to obtain a measure of the expected growth rate of the market.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Forward looking approaches: Top down approach


The top down approach uses a combination of the dividend yield model and long-term GDP growth to estimate expected returns.


The model takes the aggregate current dividend yield of the market and adds to this long term GDP growth as an estimate for growth in corporate dividends.


The rational for using GDP growth as an estimate for the growth of dividends is that it is a reasonable assumption that the share of profits in GDP will remain constant in the future. This would imply that GDP growth could be a satisfactory estimate for the growth of corporate dividends.


E.g. If the aggregate dividend yield in the market was 3% and estimated long term GDP growth 2,5% then the future equity returns are estimated 5,5%.


With a risk free rate of 2%, this would imply a 3,5% EMRP.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Summary on EMRPs to use


Depending on whether you look at historic (arithmetic or geometric) or future approaches to determining the EMRP one gets different numbers.


Under here I summarize the possible outcomes for EMRPs to use (in developed markets):

-EMRP historic: Between 4% and 8%;

-EMRP forward looking: Between 2% and 6%.


I believe that for every valuation professional it is very important to pick an EMRP in your models and valuation reports WITH a source, and explanation on how, and why, you think this EMRP is suitable for your valuation.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Next blog next week


In hope you liked this introduction on the EMRP and CAPM. 😊


In my next blog, next week, I will talk about whether “CAPM is dead” or still very alive and useful.


And when you have any questions in the mean time do not hesitate to contact me on:


Sources used for this blog


· The real cost of capital: A business field guide to better financial decisions (2004). Prentice Hall Financial Times/ Pearson Education. Tim Ogier & John Rugman & Lucinda Spicer.


This book is fantastic and very practical, just a pleasure to read for every investment professional. Highly recommended! 😊


Training Calendar on Business Valuation of Joris Kersten:


In case you like additional in class training:


In my home country The Netherlands, and abroad, I provide open training programs in “Business Valuation” and “Financial Modelling”.


The next sessions are given below:

1. Business Valuation & Deal Structuring (6 day training): 18, 19, 20, 21 and 23, 24 March 2020 @ Uden in the South of The Netherlands;

2. Financial Modelling in Excel (4 day training): 20, 21, 22, 23 April 2020 @ Uden in the South of The Netherlands;

3. Financial Modelling in Excel (5 day training): 2, 3, 4, 5, 6 February 2020 @ Riyadh in Saudi Arabia.

All info on these open training sessions can be found on:

And 130 references on my training sessions can be found on:


Trainer & Consultant: J.J.P. (Joris) Kersten, MSc BSc RAB


· 130 recommendations on his training can be found on:


· His full profile can be found on:


J.J.P. (Joris) Kersten MSc BSc RAB (1980) is owner of “Kersten Corporate Finance” in The Netherlands, under which he works as an independent consultant in Mergers & Acquisitions (M&A’s) of medium sized companies.


Joris performs business valuations, prepares pitch books, searches and selects candidate buyers and/ or sellers, organises financing for takeovers and negotiates M&A transactions in a LOI and later in a share purchase agreement (in cooperation with (tax) lawyers).


Moreover, Joris is associated to ‘AMT Training London’ for which he provides training as a trainer and assistant-trainer in Corporate Finance/ Financial Modelling at leading investment banks in New York, London and Hong Kong.


And Joris is associated to the ‘Leoron Institute Dubai’ for which he provides finance training at leading investment banks and institutions in the Arab States of the Gulf.


In addition, Joris provides lecturing in Corporate Finance & Accounting at leading Universities like: Nyenrode University Breukelen, TIAS Business School Utrecht, the Maastricht School of Management (MSM), the Luxembourg School of Business and SP Jain School of Global Management in Sydney.


Moreover, he provides lecturing at partner Universities of MSM in: Peru, Surinam and Mongolia. And at partner Universities of SP Jain in Dubai, Mumbai and Singapore.


Joris graduated in MSc Strategic Management and BSc Business Studies, both from Tilburg University. In addition, he is (cum laude) graduated as “Registered Advisor Business Acquisitions” (RAB), a 1-year study in the legal and tax aspects of M&A’s. And Joris obtained a degree in “didactic skills” (Basic Qualification Education) in order to lecture at Universities.


Currently Joris is doing the “Executive Master of Business Valuation” to obtain his title as “Registered Valuator” (RV) given out by the “Netherlands Institute for Registered Valuators” (NIRV). This title will enable Joris to give out business valuation judgements in for example court cases.


J.J.P. (Joris) Kersten, MSc BSc RAB. Email: Phone: +31 6 8364 0527


Earlier blogs on “Business valuation to Enterprise Value”


From June until August I have written the following blogs on valuation:


1. Leveraged Buyout Analysis (LBOs);


2. M&A Analysis” (M&A model – Accretion/ Dilution);


3. Discounted Cash Flow Valuation (DCF);


4. Valuation Multiples 1 – Comparable Companies Analysis (comps);


5. Excel Shortcuts & Business Valuation;


6. Valuation Multiples 2 – Precedent Transaction Analysis.


You can find them on the links below:


1) LBO Analysis (June 9th 2019):


2) M&A Analysis (June 20th 2019):


3) Discounted Cash Flow Valuation (July 24th 2019):


4) Valuation Multiples 1 – Comparable Companies Analysis (August 26th 2019):


5) Excel Shortcuts & Business Valuation (August 28th 2019):


6) Valuation Multiples 2 – Precedent Transaction Analysis (August 19th 2019):


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