Simultaneous Determination of Market Value and Risk Premium in the Valuation of Firms
University of Manchester - School of Economic Studies
October 12, 2011
ICER Working Paper No. 15/2011
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.
Number of Pages in PDF File: 15
Keywords: firm valuation, DCF, CAPM, risk premium, transfer pricing
JEL Classification: G1, G3, M4working papers series
Date posted: October 17, 2011
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