COVID-19 and the Equity Risk Premium Used in Business Valuation

COVID-19 persists in affecting nearly everything, including business valuation.  We continue to monitor developments in the economic landscape at large, as well as within the business valuation community.  One thing that we have all witnessed is that COVID-19 has added uncertainty and therefore, more risk to the U.S. and worldwide economies.

A primary business valuation method that is impacted by COVID-19 is the Income Approach, which is based on the principle that the fair market value of an entity may be measured by the present value of its future cash flows.  The present value is calculated through the use of a discount rate.  A discount rate is the way an investor reflects the risks of an investment.  In simple terms, the higher the risk, the higher the rate of return required.

One element of the discount rate that has been directly impacted by COVID-19 is the equity risk premium (“ERP”).  An ERP reflects the additional return that investors demand for investing in equity securities, as a group, relative to risk-free investments.

One measure of an equity risk premium is regularly provided by Duff & Phelps.  Effective March 25, 2020, Duff & Phelps increased its ERP estimate from 5% to 6%, an increase of 20%.  The rise in the Duff & Phelps ERP reflects some of the additional economic and financial risks of COVID-19 to investors.  An increase in risk, and required rate of return to investors through the ERP, with no other changes in expected cash flow, will generally lower the value of a business.

As COVID-19 continues to impact both Wall Street and Main Street, we will continue to assess the situation and the impact on business valuation.  If you would like to discuss opportunities for gift and estate planning during this unprecedented time or have other business valuation questions, please feel free to reach out.

Schneider Downs has significant experience in preparing business valuations for gift and estate tax, financial reporting, buying/selling and a range of other purposes. Please contact Steve Thimons (412-697-5281; sthimons@schneiderdowns.com) or Thomas D. Pratt (412-697-5615; tpratt@schneiderdowns.com) for more information about our business valuation services.

You’ve heard our thoughts… We’d like to hear yours

The Schneider Downs Our Thoughts On blog exists to create a dialogue on issues that are important to organizations and individuals. While we enjoy sharing our ideas and insights, we’re especially interested in what you may have to say. If you have a question or a comment about this article – or any article from the Our Thoughts On blog – we hope you’ll share it with us. After all, a dialogue is an exchange of ideas, and we’d like to hear from you. Email us at contactSD@schneiderdowns.com.

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2020 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

our thoughts on

Tracking and Communicating COVID-19 at Your College or University
‘Tis the Season – Cybersecurity and Holiday Shopping
Fake News or Fake Truck? Hindenburg Alleges Nikola One Videos Were Faked
How Descriptive, Diagnostic, Predictive and Prescriptive Analytics Can Be Used To Stop Fraud in Its Tracks
Coronavirus Fraud: Unfortunately, We Told You So

Register to receive our weekly newsletter with our most recent columns and insights.

Have a question? Ask us!

We’d love to hear from you. Drop us a note, and we’ll respond to you as quickly as possible.

Ask us

contact us

Map of Pittsburgh Office
Pittsburgh

One PPG Place, Suite 1700
Pittsburgh, PA 15222

contactsd@schneiderdowns.com
p:412.261.3644     f:412.261.4876

Map of Columbus Office
Columbus

65 East State Street, Suite 2000
Columbus, OH 43215

contactsd@schneiderdowns.com
p:614.621.4060     f:614.621.4062

Map of Washington Office
Washington, D.C.

1660 International Drive, Suite 600
McLean, VA 22102