New Estimates Of The Equity Risk Premium And Why Business Economists Need Them

The equity risk premium (ERP) is used to estimate a firm's cost of equity and overall cost of capital. It therefore is relevant to, for example, capital budgeting analyses and calculation of economic value added. Unfortunately, current estimates of the ERP range widely. Some claim it has fallen to as low as around 2%, while others place it at 3 to 4 times this amount. Using a model that extracts the required return on equity from a valuation model based on dividends and repurchases of shares the ERP is estimated. This approach leads to estimates of the ERP of 3% to 6%.