June Formulas Practice

Equity Risk Premium: Damodaran country risk rating model

ERP = Developed market ERP + (λ x Country risk premium)

• Lambda = Level of the exposure of company to the local country

Country Risk Premium

Country risk premium = Sovereign yield spread x ((σEquity) / (σBond))

• σEquity = Volatility of local country’s equity market

• σBond = Volatility of local country’s bond market

Fama-French five-factor model

Re = Rf + β1ERP + β2SMB + β3HML + β4RMW + β5CMA

• ERP → Market Risk

• SMB → Size

• HML → Value

• RMW → Profitability

• CMA → Investment

Cost of equity (Re): BYPRP approach

Re = Rd + RP

Perceived mispricing equation

Ve - P = (V - P) + (Ve - V)

• (V - P) → True mispricing

• (Ve - V) → Model error value

• Ve = Estimated value (knowable)

• P = Market price (knowable)

• V = Actual intrinsic value (unknowable)

PEG ratio (P/E-to-growth ratio)

PEG ratio = (P/E) / (100 x g)

• Uses total company growth

• Assumes a linear relationship between P/E and growth

• Does not account for differences in risk between companies

Earnings Rield Ratio

Earnings yield = EPS / Share price