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Simultaneous determination of market value and risk premium in the valuation of firms

Stefan Lutz

No 2012-25, Documentos de Trabajo del ICAE from Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico

Abstract: Valuing a firm using the discounted cash flow method (DCF) requires the joint determination of the market value of its equity (MVE) together with the equity risk premium (ERP) the firm should earn, since the latter is part of the discount rate used in the calculation of the MVE. This paper presents a theoretical derivation of how MVE and ERP can be calculated simultaneously under fairly general conditions. Besides firm data on free cash flow to equity the only external data needed are the risk-free rate of interest and a parameter indicating the required market risk premium per return volatility.

Keywords: firm valuation; DCF; CAPM; risk premium; transfer pricing. (search for similar items in EconPapers)
JEL-codes: G1 G3 M4 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2012, Revised 2012-10
New Economics Papers: this item is included in nep-cfn
Note: The views expressed in this paper are those of the author and do not necessarily reflect those of the institutions he is affiliated with. Any information presented is of a general nature and does not address individual circumstances of any particular person or entity. The author would like to thank Nils Holinski for helpful comments and suggestions as well as Nitish Maini and Keshav Goel for diligent research assistance; the usual disclaimer applies. Financial support by the International Centre for Economic Research (ICER), Torino, Italy, and by the Spanish Ministry of Education and Science (Grant No. ECO2008-06191) is gratefully acknowledged.
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Related works:
Working Paper: Simultaneous determination of market value and risk premium in the valuation of firms (2011) Downloads
Working Paper: Simultaneous determination of market value and risk premium in the valuation of firms (2011) Downloads
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