June 2020 update: U.S. Normalized Risk-Free Rate to 2.5%

D&P lowers U.S. normalized risk-free rate to 2.5%

Duff & Phelps has decreased its recommended U.S. normalized risk-free rate from 3.0% to 2.5% for use as of June 30, 2020, according to

https://www.duffandphelps.com/insights/publications/cost-of-capital/us-normalized-risk-free-rate-lowered-june-30-2020.

This new rate, used in conjunction with a (reaffirmed) recommended equity risk premium of 6.0%, implies a “base” U.S. cost of equity capital estimate of 8.5% (6.0% + 2.5%).

Personal note: Market risk premium of 6% is not really a big gap from what many analysts believe that 5% has been used in many sources as a reliable estimate of the MRP, based on historical data and forward-looking market data. Since that the recently outbreak of Covid-19 pandemic, has shifted upward the MRP to be 6% as mentioned by D&P above.

Quoted from Business Valuation Resources (BVR):

Most use spot yield: The concept of normalizing the risk-free rate emerged around the time of the 2008 financial crisis and is generally based on historical rates. A number of thought leaders disagree with the use of a normalized rate, including Professor Aswath Damodaran of the New York University Stern School of Business, who wrote that “you should be using today’s risk free rates and risk premiums, rather than normalized values, when valuing companies or making investment assessments.” In a BVWire survey from last year, most respondents said they use the 20-year spot yield on Treasury bonds for their risk-free rate. A quarter of respondents said they use the D&P normalized risk-free rate.

Posted in ARTICLES & VIDEOS, COST OF CAPITAL.

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