Risk premium
A risk premium is a rate of return added to a base rate, such as a risk-free rate, to reflect the extra risk of an asset, business or investment. CBV Institute lists equity, size, industry and company-specific premiums among its examples.
A risk premium is one way a rate of return reflects risk. CBV Institute defines it as a rate of return added to a base rate, for example a risk-free rate, to reflect the incremental risk of an asset, business or investment. Its examples include an equity risk premium, a country risk premium and a size premium, and its build-up model adds an industry risk premium.
Company-specific risk
CBV Institute defines a company-specific risk premium as an adjustment to the cost of equity for risk particular to the business, and gives significant customer concentration as an example. The Canada Revenue Agency’s Information Circular 89-3 expresses risk in a going concern valuation as the capitalization rate. It names the specific risk of the stability or irregularity of the earnings or cash flows among the factors. See capitalization rate and what drives a business valuation multiple.
What to check or ask
- Which premiums were added, and what each is meant to reflect
- Whether the same risk is counted twice, in the premium and in the cash-flow forecast
- What evidence supports a company-specific adjustment
Sources
This definition is checked against primary sources. Links were last confirmed on the dates shown.
- 01CBV InstituteIndustryPractice Bulletin No. 2: International Valuation Glossary – Business Valuation
- 02Canada Revenue AgencyGovernmentPolicy Statement on Business Equity Valuations
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