Market risk premium

The market risk premium (MRP) is the excess return expected by investors for holding a diversified market portfolio rather than a risk-free asset: MRP = E(Rm) - Rf. It is a fundamental parameter of the CAPM and therefore of the cost of equity and WACC. Empirically, it is estimated from long-run historical market returns, survey data (Duff & Phelps, Damodaran) or implied market premium models. For Swiss valuations, the MRP typically ranges from 5.5% to 7.0%, while French valuations use similar ranges anchored on the CAC 40 equity risk premium. The choice of MRP should be consistent with the risk-free rate convention used. Practitioners commonly retain a premium within the ranges published by recognised sources and keep it stable across valuations, letting company-specific risks be captured through beta, size and specific risk premiums rather than through ad hoc MRP adjustments.

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Example: for a Swiss SME valuation, Hectelion retains an MRP of 6.5% (consistent with Damodaran's implied ERP for mature European markets). Applied with a levered beta of 1.05 and a risk-free rate of 1.0%, the equity risk premium component is 1.05 × 6.5% = 6.8%, driving the cost of equity to 11.3% before size and specific risk premia. A 1% change in MRP shifts the enterprise value by approximately 8–12%.

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At Hectelion, the market risk premium is selected and documented with reference to current market data, ensuring WACC conclusions reflect the actual risk environment at the valuation date.