Duff & Phelps Recommended U.S. Equity Risk Premium
Decreased from 6.0% to 5.5%, Effective December 9, 2020
C LI E NT A LE R TExecutive Summary
The Equity Risk Premium (ERP) changes over time. Fluctuations in global economic
and financial conditions warrant periodic reassessments of the selected ERP. Basedon current market conditions, Duff & Phelps is decreasing its U.S. Equity Risk Premium
recommendation from 6.0% to 5.5% when developing discount rates as of December 9,2020 and thereafter, until further guidance is issued. This ERP recommendation is to
be used in conjunction with a normalized risk-free rate of 2.5%, implying a “base”
cost of equity capital estimate of 8.0% (2.5% + 5.5%).
The Equity Risk Premium (ERP) is a key input used to calculate the cost of capital within
the context of the Capital Asset Pricing Model (CAPM) and other models. Duff & Phelps
regularly reviews fluctuations in global economic and financial conditions that warrant
periodic reassessments of ERP. Based on current market conditions, we arerecommending a decrease in the U.S. ERP from 6.0% to 5.5% when developing
discount rates as of December 9, 2020 and thereafter, until further guidance is issued.
We will maintain our recommendation to use a 5.5% U.S. ERP when developing discountrates until such time evidence indicates equity risk in financial markets has materiallychanged.
The current ERP recommendation was developed in conjunction with a “normalized”

8.0%

U.S. Base Cost of Equity(Normalized Risk-Free Rate+ D&P Recommended U.S.
Equity Risk Premium)

20-year yield on U.S. government bonds of 2.5% as a proxy for the risk-free rate (R f),implying an 8.0% (2.5% + 5.5%) “base” U.S. cost of equity capital estimate as ofDecember 9, 2020. Were we to use the spot yield-to-maturity on 20-year U.S. Treasuries
instead, we would have to increase the ERP assumption accordingly. For illustrative
purposes, one can determine the ERP inferred by D&P Recommended U.S. ERP (used inconjunction with the normalized risk-free rate) against the spot 20-year yield of 1.5% asof December 9, 2020, by using the following formula:

U.S. ERP Against Spot 20-Year Yield (Inferred) == D&P Recommended U.S. ERP + Normalized Risk-Free Rate – Spot 20-Year U.S. Treasury Yield= 5.5% + 2.5% – 1.5% = 6.5%

The Content in this Client Alert was written in early December 2020. Some events described as sourcesof uncertainty may have been resolved or shifted in different directions.

2Duff & Phelps

Background
Duff & Phelps last changed its U.S. ERP recommendation on March 25, 2020. On that date,
our recommendation was increased to 6.0% (from 5.0%) in response to financial markets’
turmoil and the uncertainty created by the decision of countries around the world to enact
lockdown policies to limit the spread of the novel coronavirus (COVID-19) andcorresponding impact on the global economy.
The World Health Organization (WHO) declared COVID-19 as a pandemic on March 11,
2020, which led to an unprecedented reaction in global financial markets and major
disruption to the global economy. Government policies of social distancing have led
to supply chain disruptions and the closure of many businesses, harming business
confidence; this has led to significant job losses in several industries, in turn hurting
consumer confidence. Following the COVID-19 outbreak, U.S. equity markets collapsed
at a speed faster than observed during the global financial crisis of 2008 and 2009
(the “Global Financial Crisis”). Equity volatility reached record highs, while corporate
credit spreads surged, plunging the U.S. economy into a recession.

Anatomy of Crisis:
Background and WhereWe are Today

The U.S. government and the Federal Reserve Bank (Fed) reacted decisively and swiftly.
The U.S. government approved a sizable fiscal stimulus package to support businesses
and consumers (the “CARES Act”). The Fed implemented large rounds of quantitative easing
and other crisis-related measures akin to those employed during the Global Financial Crisis,
and also added new programs to keep corporate credit and mutual funds markets
functioning. Importantly, the Fed introduced a new corporate bond purchase program
to buy investment-grade corporate bonds, as well as junk bonds issued by “fallen angels”(i.e., corporations whose debt rating had previously been classified as investment grade,but were downgraded to ‘speculative’ or junk due to the COVID-19 crisis), thereby
contributing to a fall in corporate debt yields.
As of June 30, 2020, global equity markets had recovered substantially from their mid-Marchlows – benefiting from unparalleled monetary actions by central banks and fiscal stimulus
packages by several governments – but several global benchmark equity indices had not yet
recovered to the levels achieved in mid-February 2020 (prior to their large March declines).
Equity volatility had decreased from the record highs reached in March but remained
elevated. U.S. consumer confidence and business optimism had recovered slightly, but
the former was still significantly lower than it was before COVID-19, and job losses in several
industries (and the unemployment rate) continued to be at historic high levels. Economists
had further slashed real economic growth projections for 2020, and many analysts predicted
a more severe contraction of the global economy than was experienced during the Global
Financial Crisis. Based on the economic and financial market conditions prevailing as ofJune 30, 2020, Duff & Phelps reaffirmed its U.S. ERP recommendation of 6.0% to be usedin conjunction with a normalized risk-free rate. However, based on academic research
pointing to lower real interest rates and declining long-term growth estimates for the U.S.
economy, we lowered the U.S. normalized risk-free rate from 3.0% to 2.5%, when developing
discount rates as of June 30, 2020 and thereafter until further guidance was issued.
At that time (June 30, 2020), the decision to reaffirm the U.S. ERP recommendation took
into consideration the improvements seen in financial markets, but the degree of uncertainty
continued to be high when it came to assessing the ultimate impact of the economic
recession on companies’ earnings, and the shape that the recovery would take. In addition,
the U.S. presidential election on November 3, 2020 had the potential introduce even more
uncertainty to the economic environment.

Duff & Phelps3Conditional Equity Risk Premium Update
The lockdown policies helped slow the expansion of the virus in the U.S., and the support fromthe U.S. government and the Fed kept businesses and consumers afloat. By the end of springand into the summer of 2020, businesses started to reopen, and the economy started to show
some signs of recovery. After collapsing 5% and 31.4% in the first and second quarters of 2020,
respectively, the U.S. economy grew in real terms by an annualized 33.1% in the third quarter.1
Nevertheless, by the end of the third quarter, nominal U.S. gross domestic product (GDP)remained at a lower level than at year-end 2019. Furthermore, real GDP is still expected tocontract in 2020 by the worst percentage amount since World War II.
In the fourth quarter of 2020, U.S. equity markets reached new all-time highs, spurred byoptimism about new COVID-19 vaccines and the expectation of continued support by theFed (including ultra-low interest rates through at least 2023, and possibly longer), coupled withlower uncertainty regarding the impact of U.S. presidential elections on the economy and future
corporate earnings. Equity volatility reverted to levels close to long-term averages, and corporate

Basis for Estimating theU.S. Equity Risk Premium
as of December 9, 2020

credit spreads have narrowed to historical averages. Consumer confidence and business
optimism improved, although the former is still far below the levels observed prior to the outbreak.
Duff & Phelps goes beyond historical measures of ERP by examining approaches that aresensitive to current economic and financial market conditions. In Exhibit 1 we list the primaryfactors considered when arriving at the Duff & Phelps Recommended U.S. ERP. Specifically,
Exhibit 1 documents the evolution of these factors from March 25, 2020 through November 30,2020, along with the corresponding relative impact on ERP indications.

EXHIBIT 1: FACTORS CONSIDERED IN THE U.S. ERP RECOMMENDATION:RELATIVE CHANGE FROM MARCH TO NOVEMBER 2020
FACTORCHANGE

EFFECTON ERP

U.S. Equity Markets
Implied Equity Volatility
Corporate Spreads
Economic Policy Uncertainty (EPU)
and Equity Uncertainty Indices
Historical Real GDP Growth and Forecasts
Unemployment Environment
Consumer Confidence
Business Confidence
Sovereign Credit Ratings
Damodaran Implied ERP Model
Default Spread Model

1Source: U.S. Bureau of Economic Analysis (BEA). Information accurate as of November 30, 2020.

4Duff & Phelps

Currently, the U.S. is experiencing a third wave of COVID-19 cases, which is proving
to be more severe than the first (in March and April) and the second one (in June and July).
Daily new COVID-19 cases have reached a record high in early December 2020, andso have the daily number of deaths. This new wave could lead to a stalling of the recovery,or to another period of economic contraction, as states across the U.S. have already begun(or are considering) a new round of lockdowns until COVID-19 vaccines are more
widely available.
There are still a number of risk factors and sources of uncertainty that may impact the shapeof the U.S. economic recovery and the pattern of behavior by financial markets over the next
few months:•Two vaccines (one from Moderna and another from a partnership between Pfizer andBioNTech) have shown efficacy rates around 95%. Both vaccines have been submitted
for emergency approval by the U.S. Food & Drug Administration (FDA), and shipmentsof the vaccines were expected to begin in late December. A third vaccine developed byAstraZeneca and Oxford University showed some promising but mixed results, withadditional trials required before it can be considered for FDA approval.

•There are still a number ofrisk factors and sourcesof uncertainty that may
impact the shape of theU.S. economic recovery

The rollout of the vaccines to the public is expected to initially be limited to thoseindividuals considered to be at high risk, such as health care and other critical workers,
as well as nursing home residents. Manufacturing, supply chain, and distribution
challenges are anticipated to negatively impact the speed of delivery, but the vaccines
are nonetheless expected to be accessible to most of the U.S. population by mid-2021.
Another potential challenge is the resistance among certain pockets of the population
to receive COVID-19 inoculations, which may slow the achievement of “herd” immunity.

•Until the COVID-19 health crisis is resolved, either through vaccination(s) or better
treatments, the economy may be unable to fully recover. Fed chairman Jerome Powelland other members of the Federal Open Market Committee (FOMC) have stated that
additional fiscal stimulus is needed to support the fragile economic recovery and preventa possible relapse.2•Agreement on a second major fiscal stimulus package proved to be difficult anddiscussions have been fraught with political division. The U.S. Congress and the WhiteHouse have been unable to agree on the size and scope of a new stimulus package, but
it now appears that the approval of a smaller, more limited bipartisan package may bepossible before year end.

•As more states certify their U.S. presidential election results, uncertainty around theelection is lessening. Financial markets appeared to initially welcome a potentially divided
legislature, with Republicans in control of the U.S. Senate and Democrats controllingthe House of Representatives, making it less likely that large increases in corporate andindividual tax rates and other potentially business-unfriendly ideas proposed during theelection campaign would be enacted. Ultimate control of the Senate will be decidedin January 2021 after the Georgia run-off elections; a loss of the two Republican seatswould give Democrats control of the Senate, which could lead to the enactment ofbusiness-unfriendly legislation that lowers future after-tax corporate earnings.

The Fed has the responsibility for setting monetary policy in the U.S. by controlling the three tools of monetary
policy: open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal
Reserve System is responsible for setting the discount rate and reserve requirements, while he FOMC is thecommittee charged under U.S. law with overseeing the nation’s open market operations (i.e., the Fed’s buying andselling of U.S. Treasury securities).
2

Duff & Phelps

5Conclusion
Taken together, we find sufficient support to decrease our ERP recommendation relative
to our previous recommendation, although not yet to the same level recommended atyear-end 2019.3 Accordingly, Duff & Phelps recommends a U.S. Equity Risk Premiumof 5.5% when developing discount rates as of December 9, 2020 and thereafter, until
further guidance is issued. This recommendation is to be used in conjunction with anormalized risk-free rate of 2.5%, implying an 8.0% (2.5% + 5.5%) base cost of equity(i.e. assuming a market beta of 1.0).
While this recommendation has an effective date of December 9, 2020, some of thefactors that were considered when lowering the D&P Recommended U.S. ERP to 5.5%
were already present in late November, such as positive vaccine news and the partial
resolution of U.S. election results.

3

At year-end 2019, the Duff & Phelps’ U.S. equity risk premium recommendation was 5.0%.

Authors

Contributors

Carla S. Nunes, CFAManaging Director
carla.nunes@duffandphelps.com

Anas Aboulamer, PhD
Directoranas.aboulamer@duffandphelps.com

James P. Harington
Directorjames.hamington@duffandphelps.com

Kevin MaddenVice President
kevin.madden@duffandphelps.com
Kevin Latz
Analystkevin.latz@duffandphelps.com

About Duff & Phelps

M&A advisory, capital raising and secondary market advisory services in the United

Duff & Phelps is the world’s premier provider of governance, risk and transparency

States are provided by Duff & Phelps Securities, LLC. Member FINRA/SIPC. Pagemill

solutions. We work with clients across diverse sectors in the areas of valuation,

Partners is a Division of Duff & Phelps Securities, LLC. M&A advisory, capital raising

corporate finance, disputes and investigations, cyber security, claims administrationand secondary market advisory services in the United Kingdom are provided by Duff &and regulatory compliance. With Kroll, the leading global provider of risk solutions,Phelps Securities Ltd. (DPSL), which is authorized and regulated by the Financial

and Prime Clerk, the leader in complex business services and claims administration,

Conduct Authority. Valuation Advisory Services in India are provided by Duff & Phelps

our firm has nearly 4,000 professionals in 25 countries around the world.

India Private Limited under a category 1 merchant banker license issued by theFor more information, visit www.duffandphelps.com.

Securities and Exchange Board.

© 2021 Duff & Phelps, LLC. All rights reserved. DP203608