Equity Risk Premium
The Incremental Return Demanded by Equity Investors Above the Risk-Free Rate
The Equity Risk Premium (ERP) is the foundational building block of every cost-of-equity calculation — and therefore of every DCF, WACC, and income-approach valuation. Equitest sources ERP data from Damodaran's research across 152 countries, updated annually, and applies it transparently in every report.
What Is the Equity Risk Premium?
The Equity Risk Premium is the excess return that investors require for holding equities over a theoretically risk-free investment — typically government bonds. It is not a fixed number. It varies by country, market conditions, and time period, and is one of the most actively debated inputs in quantitative finance.
In the CAPM framework, the ERP enters the cost-of-equity formula directly: Ke = Rf + β × ERP. In the Build-Up Method used for private company valuations, the ERP is the first additive premium on top of the risk-free rate. Either way, a difference of 1–2 percentage points in the ERP assumption can shift the concluded Enterprise Value by 15–25% in a typical DCF — making it one of the most consequential inputs in the entire valuation.
For cross-border valuations, the ERP must also incorporate a Country Risk Premium (CRP) — the additional return demanded by investors for the political, economic, and currency risks specific to the country of operations. Equitest handles both the base ERP and the CRP in Chapter 20 using Damodaran's annual country-level datasets.
The ERP in the Cost-of-Equity Formula
How Equitest Sources and Applies the ERP
Chapter 20 handles the full ERP and CRP stack — sourced, disclosed, and applied transparently in every valuation report.
Damodaran ERP Database — 152 Countries
Equitest integrates Professor Aswath Damodaran's (NYU Stern) annual ERP and Country Risk Premium dataset — the most widely cited source in professional valuation practice and accepted by the IRS, SEC, and major arbitration panels. The database covers 152 countries with implied ERP estimates updated each January. Equitest stores these in a versioned database table, preserving the historical value applicable at any report date for compliance and audit trail purposes.
Automatic CRP Layering for Non-US Markets
For companies operating outside the US, Equitest automatically adds the Damodaran-derived Country Risk Premium on top of the base US ERP. The CRP reflects sovereign credit risk, political risk, and market illiquidity for each country. For multinational companies with revenue across multiple geographies, Equitest applies a revenue-weighted blended CRP — weighting each country's CRP by the share of revenue derived from that market.
Implied vs. Historical ERP — Both Disclosed
Two primary ERP estimation methodologies exist: the historical ERP (average realized excess equity return over a long historical period) and the implied ERP (derived from current market prices and analyst earnings expectations). Equitest displays both — using the Damodaran implied ERP as the primary estimate, consistent with forward-looking DCF methodology, while disclosing the historical ERP as a cross-reference. The rationale for using the implied estimate is documented in the report.
ERP Sensitivity on Enterprise Value
Because ERP flows through to WACC and then to every discounted cash flow, Equitest shows a dedicated ERP sensitivity table in Chapter 20 — displaying how Enterprise Value changes across a ±200 bps range around the base ERP. This gives the reader an immediate quantified sense of how much valuation uncertainty is attributable to ERP estimation risk, separate from growth rate or terminal value uncertainty.
ERP as the Base Layer in the Build-Up Stack
For private company valuations where a beta cannot be reliably estimated from public market data, Equitest uses the Build-Up Method for the cost of equity: Rf + ERP + CRP + Size Premium + Industry Risk Premium + Company-Specific Risk Premium. The ERP is the base layer — and Chapter 20 presents the full additive build-up stack with each component sourced, quantified, and disclosed, creating an auditable path from risk-free rate to total cost of equity.
Auto-Feeds the Cost of Equity in Chapter 21
The ERP and CRP values finalized in Chapter 20 automatically flow into the CAPM and Build-Up calculations in Chapter 21 (Cost of Equity / WACC). No re-entry is required. If the analyst overrides the Damodaran-sourced ERP with a custom value, the override and its rationale are flagged and documented in both Chapter 20 and the Chapter 21 WACC disclosure — maintaining a full compliance audit trail.
ERP Components — Step by Step
Identify the Risk-Free Rate
The risk-free rate is anchored to the current yield on a long-duration government bond matching the DCF projection horizon — typically the 10-year US Treasury yield for USD-denominated valuations. Equitest pre-loads the current rate and documents the date of observation.
Apply the Base Equity Risk Premium
The Damodaran implied ERP for the base market (US) is loaded automatically from the versioned database. This represents the additional return demanded by equity investors above the risk-free rate for investing in a diversified equity portfolio.
Add the Country Risk Premium
For non-US or multi-geography companies, the country-specific CRP is added. For multinationals, a revenue-weighted blended CRP across operating geographies is computed and applied. The CRP source, derivation method, and value are all disclosed in the report.
Apply Beta (CAPM) or Additional Premiums (Build-Up)
In CAPM, the ERP is multiplied by the company's levered beta to derive the equity risk component. In the Build-Up Method, additional premiums for size and industry are stacked on top. Equitest handles both methods and presents their outputs side by side for cross-validation.
Flow to WACC in Chapter 21
The total cost of equity derived from the ERP stack flows automatically into the WACC calculation in Chapter 21, where it is weighted by the equity proportion of the target capital structure alongside the after-tax cost of debt. The ERP assumption is disclosed at every step.
