 # WACC: Specific Company Risk Premium

Anyone help me determine a good way to arrive at this metric for a WACC calculation?

I might be mistaking, but shouldn’t WACC incorporate any risk premiums on a company already as the cost of debt, equity, and hybrid financings adjust to the riskyness of a firm?

Correct but part of the Cost of Equity is the RiskPremium and I’m not sure where to get an accurate percentage. ke = rf + (Beta x rp) + rs rf = yield on 20 year treasury bond Beta = taken from MSN Money rp = spread between 12 month trailing return on S&P 500 less rf rs = ???

if you’re going to use the CAPM then i believe it’s: Ke = Rf + B(Rm-Rf) Beta shoudl incpororate the additional risk. I’m not sure where you get Rs from…?

I think the question assumes CAPM assumptions don’t hold (specifically that the investor is holding the market), so we can’t assume that diversifiable risk is mitigated. There don’t appear to be any hard and fast rules for estimating specific company risk premium. Here’s one treatment: http://www.highlandglobal.com/index-8%20-%20Specific%20Company%20Risk%20Premium.html Google points to many other approaches…

I have an article on it, if you want to send me your e-mail address

4 steps to understanding WACC; -WACC is the Weighted Cost of Capital, which means the culmination or summation of all cost of capital components (cost of debt, cost of common equity and cost of prefered stock). -Bearing in mind we are dealing of the wieght so we need to multiply each component with the weight and sum it all up. -Also remember for debt, we need the “after tax cost of debt” so we subtract the b4 tax rate from 1 and multiply the result with the before tax rate. - So we have WACC = (wd)[kd(1-kd) + (wps)(kps) + (wce)(kce) where wd = weight of cost of debt kd = before tax rate wps = weight of prefered stock kps = rate of prefered stock wce = weight of common stock kce = rate of equity I also believe the calculation for the individual components can be done by you with ease.

Duff and Phelps has a Modified CAPM buildup method that is illustrated in the Morningstar Valuation yearbook

I think its pretty simple you dont need a text book for that; Cost of debt = kd[1- kd] Cost of Prefered (kps) = Prefered Dividend/market price of prefered Cost of Equity/Common stock = using CAPM; Kce = Risk free Rate + beta(Mkt rate - Risk Free rate) using Dividend Discount Model; Kce = (Dividend/Price) + g , where g=RR * ROE using bond yeild plus Risk Premium; Kce = Bond yeild + Risk Premium This is the best shortcut i know, it helped me…so give it go…

Thanks. Can someone explain why you cannot use levered cash flows to determine your terminal value doing a DCF if you use the WACC to get your discount rate? Hope that makes sense.

Levered Cash flows i believe is cash flow to equity, not a DCF to determine enterprise value.

You can use levered (equity) cash flows; discount them at cost of equity and add D to get TEV.

Darien, You discount & cost of equity because the debt has already been factored in already through interest expense? By “add D back” to mean add the debt component back (i.e. interest expense)? I guess you could just discount EBIT using the WACC instead? Thanks.

jmerten Wrote: ------------------------------------------------------- > Correct but part of the Cost of Equity is the > RiskPremium and I’m not sure where to get an > accurate percentage. > > ke = rf + (Beta x rp) + rs > > rf = yield on 20 year treasury bond > Beta = taken from MSN Money > rp = spread between 12 month trailing return on > S&P 500 less rf > rs = ??? Are you sure rs is ‘company’ premium and not ‘country’ premium?

Just use 12% and move on.

I just finished drawing up a CAPM model for my company and 7 competitors, incorporating just about any assumption or variation you could think of, plus a DDM model based on consensus forecasts, and lastly a big fat MCPM model (google it, it’s a pretty cool, fairly newish way to figure out Ke) complete with derivatives pricing models for the 8 companies’ entire stock of listed options and warrants, plus various assumptions for corporate bond yields… And I took the average of the results of those three models (plus a fourth, which just adds consensus EPSg to DivYield to get Ke)… AND I WHOLLY AGREE WITH HOLDSIDEANALYST

Recently, a couple of guys have come up with a way of calculating the CSRP using Aswath Damodaran’s concept of total beta. (company standard deviation/market standard deviation) The idea behind their method for calculating CSRP is that the difference in equity risk premiums calculated by first using a traditional beta and then by using a total beta can be attibutable soley to unsystematic risk, thereby demonstrating the CSRP. There are some articles explaning this method at: http://www.bvmarketdata.com/defaulttextonly.asp?f=bpmarticles