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1. Added Risk Premiums
Both experts increased the 6.86-percent rate to account for
risks that an investor in WSA would assume; i.e., “added risk
premiums”.
Spiro and Shriner both added a 7.03-percent equity risk
premium5 to account for the fact that the rate of return on stock
is less certain than on U.S. Treasury obligations. They obtained
this value, which is based on investment returns of C
corporations, from Stocks, Bonds, Bills, and Inflation: 1995
Yearbook by Ibbotson Associates, Inc.
Both experts added a 5.25-percent risk premium to account
for the fact that WSA was a small company. Both experts based
this added risk premium on data from Ibbotson Associates.
Spiro also added a 10-percent risk premium to account for
potential loss of personal lines of underwriting authority and
the fact that WSA is an S corporation. Shriner added a 9.03-
percent risk premium (7.03 percent for WSA’s tenuous relationship
with Zurich and 2 percent for its thin management and the
importance of Gelder). The sum of the risk-free rate and added
risk premiums equaled a discount rate of 29.14 percent for Spiro
and 28.17 percent for Shriner.
5 Adding the equity risk premium to the risk-free rate is a
widely accepted method. Brealey & Myers, Principles of Corporate
Finance 146-147 (5th ed. 1996); Pratt, Cost of Capital,
Estimation and Applications 62 (1998).
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Last modified: May 25, 2011