Cost of Capital in the Current Environment
Presented by:Carla S. Nunes, CFA
28 September 2022

James P. Harrington

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Valuation Advisory Highlights
World’s Leading Independent
Valuation Provider

Kroll professionals:•

Serve on AICPA task forces including: Business
Combinations, Goodwill Impairment (Co-Chair) and Private
Equity/Venture Capital•

Appointed to The Appraisal Foundation’s Appraisal
Practices Board•

Principal drafter of U.S. Private Equity Valuation Guidelines•

Provided public commentary to the OECD on base erosion
and profit shifting action items impacting transfer pricing

•

1,427

roundtables•

Professionals

engagements for more than

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Board by the International Valuation Standards Council

including 160 Managing Directors,
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In 2021 we performed overServed as panelists on IFRS and mark-to-market SEC

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clients(IVSC)•

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Participant on the EFRAG Advisory Panel on Intangibles

4

Disclaimer• Any positions presented in this session are those of the panelists and do not represent the official position of Kroll, LLC. This
material is offered for educational purposes with the understanding that neither the authors nor Kroll, LLC or its affiliates areengaged in rendering legal, accounting or any other professional service through presentation of this material.
• The information presented in this session has been obtained with the greatest of care from sources believed to be reliable, but is
not guaranteed to be complete, accurate or timely. The authors and Kroll, LLC or its affiliates expressly disclaim any liability,
including incidental or consequential damages, arising from the use of this material or any errors or omissions that may becontained in it.

5Carla S. Nunes, CFA, ABVCarla S. Nunes is a Managing Director in the Office of Professional Practice of Kroll (previously Duff & Phelps). She has over 25 years ofexperience. In that role, Carla provides firm-wide technical guidance on a variety of valuation, financial reporting and tax issues. She
also co-authors Kroll's annual U.S. and European Goodwill Impairment Studies. In addition, Carla is the Global Leader of Kroll's
Valuation Digital Solutions group, which produces cost of capital thought leadership content and data housed in the Cost of Capital
Navigator.
• In 2011, Carla completed a one-year rotation in Kroll's London office, where she promoted the firm's IFRS education efforts andmarketing initiatives, as well dealing with IFRS implementation issues.
• Prior to this role, Carla was part of the Valuation Advisory Services business unit, performing engagements primarily for financial
reporting and tax purposes at Kroll’s predecessor firms, PricewaterhouseCoopers, Standard & Poor’s, and Duff & Phelps.

Managing Director• Carla has conducted numerous business and asset valuations for a variety of purposes, including purchase price allocations, goodwill
impairment testing, M&A, corporate tax restructuring and debt analysis. She has been involved in multiple valuation assignments fora wide range of industries, including pharma & biotech, healthcare, vitamin retail, specialty chemicals, industrial manufacturing andgaming & hospitality. Carla has substantial experience with cross-border valuations, working with multinational corporations toaddress complex tax, international cost of capital and foreign exchange issues.
• Carla is one of Kroll's experts addressing valuation issues related to cost of capital. She is a co-author of the “Valuation Handbook”
series and is a co-creator of the Kroll Cost of Capital Navigator. Carla is a frequent speaker in webinars and conferences on the topics
of cost of capital, goodwill impairment and valuation in general.
• Carla is a Kroll Institute Fellow, a Practitioner Director in the Board of the Financial Management Association (FMA) International, anda member of the Education Committee of the International Institute of Business Valuers (iiBV).
• Carla received her M.B.A. in finance from the University of Rochester's Simon School, an honors degree is busines administrationfrom Lisbon's School of Economics and Management (ISEG Lisbon) and completed coursework for a Masters of Taxation from
Villanova University School of Law. Additionally, she holds a Chartered Financial Analyst (CFA) designation, an Accredited in
Business Valuation (ABV) credential, and has passed the exam and fulfilled all the requirements for the Certified in Entity andIntangibles Valuations (CEIV) credential.

6

James P. Harrington
James P. Harrington is a Director at Kroll (previously Duff & Phelps) James is a member of the Kroll Valuation Digital Solutionsgroup, which produces cost of capital thought leadership content and data housed in the Cost of Capital Navigator at
kroll.com/costofcapitalnavigator.
• James provides technical support on client engagements involving cost of capital and business valuation matters and is aleading contributor to Kroll’s efforts in the development of studies, surveys, online content and tools, and firmwide valuation
models.
• Previously, James was director of valuation research in Morningstar's Financial Communications Business where he led thegroup that produced the Stocks, Bonds, Bills, and Inflation® (SBBI®) Valuation Yearbook, Stocks, Bonds, Bills, and Inflation®
(SBBI®) Classic Yearbook, Cost of Capital Yearbook, various international cost of capital reports, and created a website
dedicated to cost of capital issues.

Director• James is co-author of the “Valuation Handbook” series with colleagues Carla Nunes and Roger Grabowski. The four Valuation
Handbooks were published as physical books starting in 2014; as of 2021 the information and data previously published inthe Valuation Handbooks has been transitioned over to the Cost of Capital Navigator at kroll.com/costofcapitalnavigator.
• James is co-author of the Stocks, Bonds, Bills, and Inflation® (SBBI®) 2021 Summary Edition with Roger Ibbotson (Professor in
the Practice Emeritus of Finance at Yale School of Management). The SBBI® 2021 Summary Edition is produced in apartnership of Kroll, the CFA Institute Research Foundation, and Morningstar, Inc.
• James is a contributing author to Cost of Capital: Applications and Examples, 5th edition, by Shannon P. Pratt and Roger J.
Grabowski (John Wiley & Sons, Inc., 2014).
• James is a contributing author to the upcoming Shannon Pratt’s Valuing a Business – The Analysis and Appraisal of Closely
Held Companies, Sixth ed. (McGraw-Hill, expected publication date 2021).

7

Table ofContents

1.

Projected Economic Growth2.

Financial Market Performance3.

Risk-free Rate Analysis

4.

U.S. Equity Risk Premium

5.

U.S. Cost of Debt

6.

Eurozone Equity Risk Premium

7.

Industry Betas

8.

Country Risk

9.

Extra Resources8

Projected Economic GrowthReal GDP Growth – Source of Estimates
We reviewed multiple sources of Real GDP Growth forecasts:
1.

International Monetary Fund (IMF)

2.

Organisation for Economic Co-operation and Development (OECD)

3.

World Bank

4.

Blue Chip Economic Indicators

5.

Consensus Economics

6.

Economist Intelligence Unit (EIU)

7.

Fitch Ratings

8.

IHS Markit

9.

Moody’s Analytics

10. Oxford Economics
11. Standard & Poor’s

10Real GDP Growth (%) Estimates by Region: World
Data as of September 15, 2022
2021

5.8
2022

2.8
2020

2023

2.0

-3.3

11

Real GDP Growth (%) Estimates by Region: United States
Data as of September 15, 2022
2021

5.7
2022
2020

-3.4

1.7

2023

0.9

12

U.S. Fiscal Policy Response to COVID-19 as a Proportion of Nominal GDP$21.4 Trillion$20.9 Trillion
Decline in
Nominal GDP =$497 Billion

Size of Combined
COVID-19 Fiscal
Stimulus Packages:

U.S. Government
COVID-19 Relief
Packages$5.7 Trillion

2019
CARES Act

2020
Consol. Appropriations Act

American Rescue Plan Act - 2021

27%

of 2019 Nominal GDP

Mar-2020 to Mar-2021
Other

Nominal GDP

13

Real GDP Growth (%) Estimates by Region: Eurozone
Data as of September 15, 2022
2021

5.2
2022

2.6
2020

-6.4

2023

0.4

14

2022 Real GDP Growth Rates of World, U.S., Eurozone
Data as of September 15, 2022

4.3%

World

2.8%

-1.7%

4.3%

Eurozone

United States

-1.5%

2.6%

-2.3%

4.0%
1.7%
Dec-2021

Sep-2022

15

Real GDP Growth (%) Estimates by Region: United Kingdom
Data as of September 15 ,2022

2021

7.4
2022

3.4
2020

-9.4

2023

0.2

16

Real GDP Growth (%) Estimates by Region: China
Data as of September 15, 2022

2021

8.1
2023
2022

5.0

3.3
2020

2.2

17

Real GDP Growth (%) Estimates by Region: India
Data as of September 15, 2022
2021

8.7

2022

7.1

2023

5.8

2020

-6.7

18

Financial Market PerformanceSince COVID Lows in March 2020
MSCI Developed, Emerging, and Frontier Markets (USD)
Developed Markets

Emerging Markets

Frontier Markets

January 2022 –April 2020 –January 2022 –April 2020 –January 2022 –April 2020 –August 2022

August 2022

August 2022

August 2022

August 2022

August 2022

Australia
Austria
Belgium
CanadaDenmark
FinlandFranceGermany
Hong Kong
IrelandIsraelItaly
Japan
Netherlands
New Zealand
NorwayPortugal
Singapore
Spain
SwedenSwitzerland
United Kingdom
United States-7.3%-38.4%-23.1%-10.9%-17.5%-19.3%-21.9%-31.1%-9.7%-29.6%-16.6%-27.0%-17.7%-33.4%-21.2%-0.8%-2.2%-14.8%-16.9%-32.8%-20.1%-10.8%-17.1%

65.6%
49.2%
8.3%
65.3%
54.3%
33.3%
35.9%
12.2%
11.0%
18.7%
35.4%
22.7%
15.7%
33.5%
-5.8%
82.0%
31.5%
16.1%
14.7%
31.3%
22.0%
33.1%
58.9%

BrazilChile
China
Colombia
Czech Republic
Egypt
GreeceHungary
India
Indonesia
Korea
KuwaitMalaysia
MexicoPeru
Philippines
PolandQatar
Saudi Arabia
South Africa
TaiwanThailandTurkeyUnited Arab Emirates

15.6%
27.9%
-19.4%-10.4%-8.3%-38.0%-14.1%-40.2%-3.3%
8.8%-26.7%
13.4%-8.4%-12.3%-4.6%-13.4%-42.8%
15.3%
10.5%-10.5%-23.3%
-3.3%
22.3%
1.2%

56.0%
56.2%
-8.8%
25.2%
129.2%-28.8%
24.2%-2.9%
106.2%
70.6%
26.4%
82.6%
10.1%
64.2%
13.4%
19.4%
-13.0%
56.6%
113.0%
50.9%
70.6%
27.6%
15.3%
106.7%

Bahrain
Bangladesh
Croatia
Estonia
JordanKazakhstan
Kenya
Lithuania
Mauritius
MoroccoNigeria
Oman
Pakistan
Romania
SerbiaSlovenia
Sri Lanka
Tunisia
Vietnam

18.2%-18.4%-6.4%-21.8%
27.1%-33.9%-21.7%-15.8%-5.1%-21.3%-1.1%
35.1%-31.9%-4.9%-4.7%-22.3%-61.8%-6.1%-25.1%

76.3%
22.7%
22.0%
32.5%
-8.1%
91.3%
8.3%
29.3%
27.4%
23.1%
92.2%
118.1%-28.4%
71.0%
23.3%
63.8%
-45.2%
1.5%
55.7%

Average-19.2%

32.4%

Average

-6.8%

44.6%

Average-11.7%

35.6%

Median-17.7%

31.5%

Median

-8.4%

39.3%

Median-15.8%

27.4%

20

S&P 500 (Price) Index (USD)
December 31, 2019 – September 23, 2022

21

STOXX Europe 600 (Price) Index (EUR)
December 31, 2019 – September 23, 2022

22

U.S. Market Crashes; S&P 500 Price is Index Benchmark

23

U.S. Market Crashes; S&P 500 Price is Index Benchmark

24

U.S. Market Crashes; S&P 500 Price is Index Benchmark

Current Situation
S&P 500
Price Index% Changesince
1/3/22

1/3/22

4,796.56–

6/16/223,666.77-23.6%

8/16/224,305.20-10.2%

9/23/22

3,693.23-23.0%

25

Risk-free Rate Analysis

10-Year Yields for U.S., Canada, U.K., Germany, Japan,
December 31, 2007 – September 15, 2022
6%
United States Treasury Constant Maturity - 10 Year
5%

Canada Government Debt - 10 Year
United Kingdom Government Debt - 10 Year

4%

Germany Government Debt - 10 Year
Japan Government Debt - 10 Year

3%

3.5%
3.2%
3.1%

2%
1.7%

1%
0.3%

0%

-1%

Source: S&P Capital IQ

27

Combined Major Central Banks Balance Sheets: Fed, ECB, BOJ, BOE
February 2020 – Mid-September 2022
% Change$25.0

After COVID-19

USD 23.6 Trillion

Feb 2020 – Sep 2022

Assets Held by Central Banks (in USD trillions)

$20.0

$15.0

Bank of England

67%

Bank of Japan-8%

European Central Bank

72%

U.S. Federal Reserve

112%

$10.0

$5.0

$0.0

Source: Federal Reserve Bank of St. Louis Economic Research and the Bank of England28

12-Month Percentage Change (%) in
Consumer Price Inflation (CPI) Index (YOY)
August 2022

Comments

United States

8.3%

Down from 8.5% in July, but still near the 40-year record high of 9.0% inJune 2022.

Canada7.0%

Down from the 7.6% gain in July 2022, the second consecutive monthly
drop, but still near 31-year record high.

United Kingdom

9.9%

Down from 10.1% in July 2022, but still near 40-year record high.

Germany*

7.9%

Ties 40-year high (May 2022 was 7.9%). Largely driven by price rises
for energy products, but to some extent food.

9.1%

Record since series creation in January 1997 (25 years ago), just prior
to the launch of the euro, driven primarily by unprocessed food andenergy prices.

Eurozone

Source: U.S. Bureau of Labor Statistics, Statistics Canada, U.K. Office for National Statistics, Germany’s Destatis Statistisches Bundesamt, Eurostat.
* Non-harmonized measure.

29

12-Month Percentage Change, CPI vs. Core Inflation (%)
November 1981 to August 2022
CPI reached a2022 high of
9.1% in June.
CPI Corereached a2022 high of
6.5% in March.

Source: U.S. Bureau of Labor Statistics, Non-Seasonally Adjusted series

30

12-Month Percentage Change, CPI Inflation by Major
Categories (%)
August 2022
23.8%

11.4%
8.3%

Inflation (All Items)

6.3%

Core Inflation (Ex-Food& Energy)

Food

EnergySource: U.S. Bureau of Labor Statistics, Non-Seasonally Adjusted series

31

U.S. Central Bank Balance Sheet
January 1, 2007 – September 14, 2022
$10,000$8.833 Trillion$9,000Fed Balance Sheet (in $billions)$8,000$7,000Mortgages$6,000$5,000$4,000$3,000$2,000Treasuries$1,000$0

Source: Cleveland Federal Reserve, S&P Capital IQ

32

Quantitative Tightening (QT)
Monthly Caps and Actual Reduction in Federal Reserve's Security Holdings (USD in Billions)

(A)

(B)

Monthly Cap:
Maturing U.S.
Treasury
Securities

Monthly Cap:
Maturing
MBS &Agency Debt

Monthly Cap:
Total Maturing
Treasuries,
MBS & Agency
Debt

End-of-Period
Cumulative
Cap (# mos. x
monthly cap)

Actual Period
ChangeHoldings(A - B)

Jun-Aug 2022

30.0

17.5

47.5

125.0

73.0

(52.0)

Sep-Dec 2022

60.0

35.0

95.0

380.0

Jan-Dec 2023

60.0

35.0

95.0

1,140.0

Total Projected Reduction
in Security Holdings by Dec 2023

Source: Federal Reserve of St. Louis. Kroll calculations$1,645.0

Shortfall(C)

33

Quantitative Tightening (QT)
Monthly Caps and Actual Reduction in Federal Reserve's Security Holdings (USD in Billions)

Actual Total Holdings
31 May 2022

Less:
Fed Projected Reduction in
Security Holdings (C)$8,479– $1,645

Fed Projected Holdings
31 Dec 2023

= $6,834 bn
Fed Actual Holdings
Pre-COVID (26 Feb 2020)$3,848 bn
Excess Holdings
31 Dec 2023+$2,896 bn
Source: Federal Reserve of St. Louis. Kroll calculations

34

Fed Funds Target Range (Dec 2008 – Sep 2022)
The Fed has raised 5 times in 2022
(a total of 300 bps).

Top of Fed Funds Target Range (%)

+ 75
bps

2022

3.25

Bottom of Fed Funds Target Range (%)
Change (+ or –) shown in Red+ 25
bps 2.50+ 25
bps 2.25+ 25
bps 2.00+ 25
bps 1.75+ 25
bps 1.50+ 25
bps 1.25+ 25
bps 1.00+ 25
bps 0.75+ 25
bps 0.50

2.00
1.75

1.50
1.25

1.00
0.75

0.25

2.25

+ 75
bps

– 25
bps

2.25

2.50

– 25
bps

2.00
2.00

+ 75
bps

– 25
bps

1.75
1.75

1.75
– 50
bps

1.25

1.00

1.50
1.00

– 100
bps

1.50

+ 25
bps

0.50

0.25

0.75
0.25

0.25

Date the Federal Open Market Committee (FOMC) Changed the Fed Funds Target Rate

2.25

+ 50
bps

0.50
0.00

3.00

0.00

35

The Risk-free Rate (Rf) – Spot Rate or “Normalized” Rate?
During periods in which risk-free rates appear to be abnormally low due to flights to quality or massive monetary
policy interventions (i.e., QE or quantitative easing)

Kroll recommends normalizing the risk-free rate:

Abnormally Low Rf

Use Normalized Risk-free Rate

36

The Risk-free Rate (Rf) – Spot Rate or Normalized Rate or“Normalized” Rate?
Normalization can be accomplished in several ways, including:1.

Simple averaging

2.

Various “buildup” methods

37

U.S. 20-Year Treasury Yield, Including Trailing Average
December 31, 2007 – September 15, 2022
2008
Financial Crisis

COVID-19

10-year moving average

5.0%

December 19, 2019
2.2%
(D&P decreases ERP to
5.0% from 5.5%)

September 15,
2022
3.8%

What is it as of
26 Sep 2022?

4.0%

3.0%

2.5%

December 31, 2008
3.1%

4.05%

2.0%

1.0%

March 25, 2020
1.2%
(D&P increases ERP to
6.0% from 5.0%)

December 09, 2020
1.5%
(D&P decreases ERP to5.5% from 6.0%)

0.0%

Source: 20-year U.S. government bond series. Board of Governors of the Federal Reserve System

38

Risk-free Rate Normalization – by Build Up“Fisher Equation”
Conceptually, the risk-free rate can be (loosely) illustrated as the return on the following two
components:*

Risk-free
Rate

Real Rate

Expected
Inflation* This is a simplified version of the “Fisher equation”, named after Irving Fisher. Fisher’s “The Theory of Interest” was first published by Macmillan (New York), in 1930. The Fisher equation is formally
expressed as (1 + Nominal Rate) = (1 + Real Rate) x (1 + Expected Inflation). When rates are low, there is very little difference between the simple form and the Fisher equation. Various academic
research papers show that the decomposition of the nominal rate into a real rate and expected inflation should include an additional component excluded from the Fisher equation: the inflation risk
premium. This premium reflects the risk that actual inflation may vary significantly from expected inflation, and it can be positive or negative, with some academic estimates at close to 0%.

39Real Rate Estimates
United States
Several academic studies have suggested the long-term real risk-free rate to be somewhere in therange of -1.1% to 2.0% based on the study of inflation swap rates, yields on long-term U.S. Treasury
Inflation-Protected Securities (TIPS), OLG, DSGE and other econometric models *-1.1 %

Long-term Real Rate

2.0%

* Based on academic studies issued between 2015 and 2022. In academic literature, this is also sometimes called the natural rate of interest, the neutral rate, or the equilibrium rate.
OLG = Overlapping Generational Model
DGSE = Dynamic Stochastic General Equilibrium Model

40

Long-Term Inflation Expectations
Estimates as of September 2022 (approximately)
SOURCESLong-Term Average (%)

Aruoba Term Structure of Inflation Expectations

2.5

Blue Chip Economic Indicators

2.9

Blue Chip Financial Forecasts

2.8

Consensus Economics

3.0

Federal Reserve Bank of Cleveland

2.3

IHS Markit

2.9

Livingston Survey(Federal Reserve Bank of Philadelphia)

2.5

Survey of Professional Forecasters(Federal Reserve Bank of Philadelphia)

2.8

University of Michigan Survey 5-10 Year Ahead Inflation Expectations

2.8

Median

2.3% – 3.0%

2.8%

Range of Inflation Estimates

41

Risk-Free Rate Normalization – United States
As of September 15, 2022

-1.1%

Long-term Real Rate

+

2.0%
+

2.3%

Long-term Expected Inflation

3.0%

=

=
1.3%*

Long-term Normalized Risk-Free Rate•

Fisher Equation: Midpoint = 3.1% / Median = 3.4%•

LT Average: 10-Year Trailing Average of 20-Year U.S. Treasury Yield = 2.5%

5.0%

What is the spot
20-year yield as of
26 Sep 2022?

4.1%

Concluded Normalized Rf = 3.5%
* Differences due to rounding.

Guidance: Use the higher of the Spot Rate or the Normalized Risk-free Rate.

42

Risk-Free Rate Normalization – Germany
As of September 15, 2022

-1.2%

Long-term Real Rate

+

1.5%
+

1.9%

Long-term Expected Inflation(Excluding 2022 Forecasts)

3.0%

What is the spot
15-year yield as of
26 Sep 2022?

=

=
0.6%

Long-term Normalized Risk-Free Rate•

Fisher Equation: Midpoint = 2.6% / Median = 3.3%•

LT Average: 10-Year Trailing Average of 15-Year Bund Yield = 0.8%

4.5%

2.1%

Concluded Normalized Rf = 2.0%
Guidance: We are considering a change to the Normalized Risk-free Rate from 2.0% to 2.5% in the near
future. Final guidance will be issued as soon as we finalize analyzing the latest data.

43

Risk-Free Rate Normalization – United Kingdom
As of September 15, 2022

-0.4%

Long-term Real Rate

2.3%

+

+

2.1%

Long-term Expected Inflation(Excluding 2022 Forecasts)

3.6%

What is the spot
20-year yield as of
26 Sep 2022?

=

=
1.6%

Long-term Normalized Risk-Free Rate

5.9%

•

Fisher Equation: Midpoint = 3.8% / Median = 3.9%•

LT Average: 10-Year Trailing Average of 20-Year U.K. Government Yield = 2.0%

4.6%

Concluded Normalized Rf = 3.5%
Guidance: We are shifting to a hybrid approach of using the higher of the Spot Rate or the Normalized Riskfree Rate by September 30, 2022. An increase of the Normalized Risk-free Rate is being considered
thereafter. Final guidance will be issued as soon as we finalize analyzing the latest data.

44

U.S. Equity Risk Premium

The Kroll Recommended ERP is a Two-Step Process
STEP 1: What is a reasonable range of unconditional ERP that can be expected over an entire business cycle?

“What is the range?”

STEP 2: Research has shown that ERP is cyclical during the business cycle. We use the term conditional ERP tomean the ERP that reflects current market conditions.

“Where are we in the range?”46

Kroll Considers Multiple Models to Estimate U.S. ERP“Historical”
ERP
Estimates

3.5%＋

Forwardlooking ERP
Estimates

Range of Unconditional ERP

6.0%
47

Kroll Considers Multiple Models to Estimate U.S. ERP

D&P
RECOMMENDED
U.S. ERP

5.5%
3.5%

Range of Unconditional ERP

6.0%

48

Factors Considered in ERP Recommendation – Summary Table
Changes from December 9, 2020 to September 15, 2022
FactorFinancial Markets

Economic Indicators

ChangeEffect on ERP

U.S. Equity Markets▲▼

Implied Equity Market Volatility▼▼

Corporate Credit Spreads▲▲

Damodaran Impllied ERP Model▲▲

Default Spread Model▲▲

U.S. Equity Market Uncertainty Index▲▲

Historical & Projected Real GDP Growth▲▼

Unemployment▼▼

Consumer Sentiment▼▲▲

Business Confidence
Sovereign Credit Ratings
Economic Policy Uncertainty (EPU) Index

▼

▼
49

Unemployment Increases for First Time Since January 2022…
…. but still near pre-COVID lows

528,000
Unemployment Rate

318,000

315,000

Change from Prior
Month

July

August

3.5%

3.7%

-0.1%

0.2%

258,000

Jul-2022

Aug-2022
Expected

ActualSources: Non-farm payrolls by Bureau of Labor Statistics; CNBC “Payrolls increased 528,000 in July, much better than expected in a sign of strength for jobs market” August 5, 2022;
CNBC “Payrolls rose 315,000 in August as companies keep hiring”, September 2, 2022.

50

U.S. Job Openings vs Number of Employed (thousands)
January 2020 to July 2022
25,000

Job Surplus of
5.57 million

20,00015,000

Job Surplus
peaked at 5.90
million in March
2022

10,0005,000

0Job openings

Unemployment

51

Spot 20-Year U.S. Government Yield in Conjunction with
Unadjusted “Historical” Equity Risk Premium *December 31, 2007 – September 15, 2022
11.6%

11.2%
9.5%

10.8%

11.2%

10.7%
9.2%

9.2%

9.5%

9.6%

9.7%

9.6%

9.8%

10.7%
9.4%

8.7%

Dec-07
Apr-08Aug-08Dec-08Apr-09Aug-09Dec-09Apr-10Aug-10Dec-10
Apr-11
Aug-11
Dec-11
Apr-12
Aug-12
Dec-12
Apr-13Aug-13
Dec-13Apr-14Aug-14
Dec-14Apr-15Aug-15
Dec-15
Apr-16Aug-16
Dec-16
Apr-17Aug-17
Dec-17
Apr-18Aug-18Dec-18Apr-19Aug-19Dec-19Apr-20Aug-20Dec-20
Apr-21
Aug-21
Dec-21
Apr-22Aug-22

8.3%

Risk-Free Rate (Spot)Historical ERP (1926-Present)

Base Cost of Equity* The Historical Equity Risk Premium is defined as the ERP over the years 1926–Present as of the date of the analysis. For example, the Historical Equity Risk Premium for December 2019spans the years 1926–2019 while the Historical ERP for 2020 spans the years 1926–2020.

52

Current U.S. Normalized Risk-free Rate and ERP
Recommendations
As of September 15, 2022
Risk-Free Rate (Spot & Normalized)
10.5%
9.5%

10.1%

9.6%

10.0%

9.5%

9.0%

Kroll Recommended U.S. ERP

Base Cost of Equity

9.0%

9.0%

9.0%

9.0%

8.5%

9.0%
8.0%

8.0%

8.0%

9.3%
8.7%

53

Cost of Debt

S&P Corporate, Financial and Sovereign Debt Downgrades Signaling Stress

Source: S&P Global “Rating Indicators Signal A Turn in Rating Momentum”, July 28, 2022

55

U.S. High Yield versus U.S. Investment Grade Corporate Bond Yields
December 2007 – September 2022

Source: Federal Reserve Bank of St. Louis. Based on the effective yields between of the ICE BofA U.S. Corporate Index and the ICE BofA U.S. High Yield Index

56

Eurozone Equity Risk PremiumSummary Table of Factors – Eurozone
Changes from December 31, 2021 to September 15, 2022
ChangeEffect on ERP

European Equity Markets▼▲

Implied Equity Market Volatility▲▲

Corporate Credit Spreads▲▲

Dividend Discount Model Implied ERP▲▲

Default Spread Model▲▲

Historical & Projected Real GDP Growth▼▲

Unemployment▼▼

Consumer Sentiment▼▲

Business Confidence

▼

▲

▲

▲

FactorFinancial Markets

Economic Indicators

Sovereign Credit Ratings
Economic Policy Uncertainty (EPU) Index

58

Conditional ERP – Quantitative Models

MODELS• Default Spread Model *• Dividend Discount Model (DDM) – Bottom-Up **• Dividend Discount Model (DDM) – Top Down (Median)* The Default Spread Model is based on the premise that the long-term average ERP (the unconditional ERP) is constant and deviations from that average over an economic cycle can be measured
by reference to deviations from the long-term average of the default spread between corporate bonds rated in the Baa category by Moody’s versus those in the Aaa rating category. For more details
see: Jagannathan, Ravi, and Wang, Zhenyu,” The Conditional CAPM and the Cross -Section of Expected Returns,” The Journal of Finance, Volume 51, Issue 1, March 1996: 3–53.
** Bottom-Up Dividend Discount Model is based on the methodology outlined in: Pástor, Ľuboš, Meenakshi Sinha, and Bhaskaran Swaminathan. "Estimating the intertemporal risk–return tradeoff
using the implied cost of capital." The Journal of Finance 63, no. 6 (2008): 2859-2897.

59

Conditional ERP – Quantitative Models
December 2014 – September 15, 2022
10%

Dividend Discount Model (DDM) — Top Down (Median)

9%

Dividend Discount Model (DDM) — Bottom-Up

8%

Default Spread Model

7%

6%

5%

6.7%
6.6%

4.9%

4%

3%

60

Dividend Discount Model (DDM) – Top Down
Defining the Models: Variation of Models Inputs
MODELS

Projected EPS – Year 1

Payout Ratio – Year 1

Payout Ratio – Other Years

1

Next 12 Months

Last 12 months

2

Next 12 Months

Last 12 months

Interpolated to 1 − 𝑅𝑅𝑅𝑅𝑅𝑅(12𝑚𝑚)

3

Next 12 Months

4

Next 12 Months

5

Historical Inflation Adjusted EPS(10 years)

10-year historical
average
10-year historical
average
10-year historical
average

𝐿𝐿𝐿𝐿𝐿𝐿

Constant
Constant

Interpolated to 1 −𝐿𝐿𝐿𝐿𝐿𝐿𝑅𝑅𝑅𝑅𝑅𝑅(10–year avg.)

Constant

ROE = Return on Equity
LTG= Long Term Growth Rate= 1 + 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐺𝐺𝐺𝐺𝐺𝐺 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 × 1 + 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 - 1
Sources of data:• Earnings projections based on Refinitiv I/B/E/S Estimates• Payout Ratios and ROE are calculated based on data obtained from Refinitiv DataStream
61

Long-term Projected Real GDP Growth
Estimates as of mid-September 2022 (approximately)Long-Term Average (%)

Last Year in the Forecast(%)

Consensus Economics

1.1

1.1

Economist Intelligence Unit

0.9

1.4

IHS Markit

1.0

1.1

International Monetary Fund (IMF)

1.2

1.1

Oxford Economics

1.2

1.0

PwC

1.2

1.3

0.9% – 1.2%

1.0% – 1.4%

SOURCEMedian1.1%

Range of Real GDP
Growth Estimates

1.1%

MedianRange of Real GDP
Growth Estimates

62

Long-term Inflation Expectations
Estimates as of mid-September 2022 (approximately)
SOURCE

Long-Term Average (%)

Consensus Economics

3.0

Economist Intelligence Unit

3.8

IHS Markit

3.4

International Monetary Fund (IMF)

2.7

Oxford Economics

2.5

PwC

3.2

Range of Inflation Estimates

2.5% – 3.8%

3.1%

Median2.4%

Median Ex-2022 Forecasts

Long Term Growth Rate (Median) = 1 + 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐺𝐺𝐺𝐺𝐺𝐺 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 × 1 + 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 - 1= (1 + 1.1%) x (1 + 2.4%) – 1 = 3.6%

63

Top Down DDM Implied ERP – All Model Specifications
January 2014 – September 15, 2022
8.5%

Trailing 12M w/Adj Payout
Trailing 12M w/Spot Payout
Trailing 12M w/10Yr Avg Payout
Trailing 12M w/Adj 10Yr Avg Payout

7.5%

Norm Earnings (10Yr Avg) w/10Yr Avg Payout

6.5%

5.5%

4.5%

3.5%
64

Top Down DDM Implied ERP – MedianJanuary 2014 – September 15, 2022
8.5%

7.5%

6.5%

Median Implied ERP (DDM)

6.6%

5.5%

4.5%

3.5%

65

Kroll Recommended Eurozone Equity Risk Premium
German Investor Perspective applied to EUR-Denominated Projections *December 31,
2019

March 31,2020

December 31,
2021

September 15,
2022 **

2.0%

2.0%

1.5%

2.0%**

Eurozone Equity Risk Premium Recommendation

4.5% to 5.0%

5.5% to 6.0%

5.5% to 6.0%

5.5% to 6.0%

Base Cost of Equity

6.5% to 7.0%

7.5% to 8.0%

7.0% to 7.5%

7.5% to 8.0%

Normalized Risk-Free Rate – Germany* Some countries may have regulations or guidelines that preclude the use of normalized risk-free rates. The Kroll approach does not supersede such local guidance. In Germany, for instance,
the IDW (Institute of German Chartered Accountants) created a committee (FAUB) whose function is to issue guidance regarding (company) valuation topics. Under FAUB guidance, whenestimating cost of capital using CAPM, a spot risk-free rate (Svensson method) should be used, while the ERP will change over time to reflect changes in the risk aversion.
** Base Cost of Equity likely to increase in the near future, assuming we increase the German Normalized Risk-free Rate from 2.0% to 2.5%.

66

Inferred ERP: Using the Kroll Eurozone Recommended ERP
Against A Spot German Risk-free Rate
As of September 15, 2022

15-Year German
Government
Spot Yield *Inferred Eurozone
ERP

Low
Range

GermanNormalized
Risk-free Rate

5.5%

+

2.0%

–

1.8%

=

5.7%

High
Range

Kroll
Eurozone
Recommended ERP

6.0%

+

2.0%

–

1.8%

=

6.2%

* Source: Deutsche Bundesbank

67

Industry Betas

COVID-19 Impact on Industry Betas
OLS Betas by Industry Before and During COVID-19 Recovery
Pre COVID-19 Beta
As of 31-Dec-2019

COVID-19 Beta
As of 30-Jun-2022

Difference

Pharmaceuticals

1.12

0.59

-0.53

Telecommunications

0.99

0.55

-0.44

Food, Beverage, and Tobacco

0.72

0.62

-0.10

Banks

0.86

0.82

-0.04

Automobiles

1.45

1.42

-0.03

Software

1.05

1.05

0.00

Insurance

0.71

0.82

0.11

Energy

1.27

1.48

0.21

Retail

0.83

1.45

0.62

Industry

Source: Based on the median OLS (raw) betas by industry from the Cost of Capital Navigator’s U.S. Industry Benchmarking Module. The summary above is based on USD-denominated returns ofcompanies in United States as of December 31, 2019 and June 30, 2022.

69

COVID-19 Impact on Industry Betas
OLS Betas by Industry Before and During COVID-19 Recovery
Industry

Pre COVID-19 Beta
As of 31-Dec-2021

COVID-19 Beta
As of 30-Jun-2022

Difference

Energy

1.71

1.48

-0.23

Banks

0.94

0.82

-0.13

Telecommunications

0.67

0.55

-0.12

Food, Beverage, and Tobacco

0.73

0.62

-0.12

Pharmaceuticals

0.70

0.59

-0.11

Automobiles

1.50

1.42

-0.08

Insurance

0.85

0.82

-0.03

Software

1.06

1.05

0.00

Retail

1.45

1.45

0.00

Source: Based on the median OLS (raw) betas by industry from the Cost of Capital Navigator’s U.S. Industry Benchmarking Module. The summary above is based on USD-denominated returns ofcompanies in United States as of December 31, 2021 and June 30, 2022.

70

Country Risk

72

Country Risk Premia Pre-and Post COVID-19

Country Yield Spread Model from a United States (USD) investor perspective*

Frontier Markets
7%
6.5%

6%

4.9%

5%
4.5%

4.3%

Emerging Markets

4%

3.2%

3.1%

3%

2.7%

2.6%
2.0%

2%

2.2%
1.8%
1.5%

Developed Markets

1.2%

1.2%

1.4%

1.5%

1.7%

2.6%
2.3%

1.9%

1.4% 1.4%

1%
0.3%

0%

0.4%

0.2% 0.2%

0.1% 0.1% 0.1% 0.1%

0.3% 0.3% 0.3%

Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun
2019 2020 2020 2020 2020 2021 2021 2021 2021 2022 2022

Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun
2019 2020 2020 2020 2020 2021 2021 2021 2021 2022 2022

Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun
2019 2020 2020 2020 2020 2021 2021 2021 2021 2022 2022

* Based on the median country risk premia of countries classified by MSCI as developed, emerging, and frontier markets. MSCI only classifies
71 countries under these three categories.
International Cost of Capital Module | https://www.kroll.com/en/cost-of-capital/international-cost-of-capital

Get insights like these and more in the Cost of Capital Navigator.

73

Country Risk Premia Pre-and Post COVID-19
By Geographic Region (Asia-Pacific)

Asia-Pacific
4.7%

3.1%

3.0%

2.8%
1.9%

1.5%

Dec 2019

Mar 2020

Jun 2020

Sep 2020

Dec 2020

1.7%

Mar 2021

1.6%

Jun 2021

International Cost of Capital Module | https://www.kroll.com/en/cost-of-capital/international-cost-of-capital

1.9%

Sep 2021

3.3%

2.1%

Dec 2021

Mar 2022

Jun 2022

74
Get insights like these and more in the Cost of Capital Navigator.

Country Risk Premia Pre-and Post COVID-19
By Geographic Region

Africa
10.0%

10.0%
7.7%

7.8%
6.1%

6.5%

6.4%

Mar 2021

Jun 2021

6.9%

7.0%

Sep 2021

Dec 2021

7.5%

5.0%

Dec 2019

Mar 2020

Jun 2020

Sep 2020

Dec 2020

International Cost of Capital Module | https://www.kroll.com/en/cost-of-capital/international-cost-of-capitalMar 2022

Jun 202275
Get insights like these and more in the Cost of Capital Navigator.

Country Risk Premia Pre-and Post COVID-19
By Geographic Region

Latin America & Caribbean
6.4%

4.7%

5.1%
4.3%
3.4%

2.9%

Dec 2019

Mar 2020

Jun 2020

Sep 2020

Dec 2020

3.2%

3.3%

Mar 2021

Jun 2021

International Cost of Capital Module | https://www.kroll.com/en/cost-of-capital/international-cost-of-capital

4.1%

4.1%

Dec 2021

Mar 2022

3.5%

Sep 2021

Jun 2022
76

Get insights like these and more in the Cost of Capital Navigator.

Country Risk Premium Before and After COVID-19 (USD)
Data as of June 30, 2022
30.0%

6.0%

COVID-19 declared a
Pandemic

5.0%

25.0%

20.0%

4.0%

Brazil

Ghana

3.0%

10.0%

1.0%

5.0%

Dec 2019

Mar 2020

Dec 2021

0.0%

Jun 2022

Dec 2019

5.0%

Mar 2020

Dec 2021

Jun 2022

35.0%

4.0%

30.0%

COVID-19 declared a
Pandemic

3.0%

Mexico

15.0%

2.0%

0.0%

COVID-19 declared a
Pandemic

Ethiopia

2.0%

25.0%
20.0%
15.0%

COVID-19 declared a
Pandemic

10.0%

1.0%

5.0%

0.0%
Dec 2019

Mar 2020

Dec 2021

Jun 2022

0.0%
Dec 2019

International Cost of Capital Module | https://www.kroll.com/en/cost-of-capital/international-cost-of-capitalMar 2020

Dec 2021

Jun 202277

Country Risk Premium Before and After COVID-19 (EUR)
Data as of June 30, 2022
30.0%

3.0%

Spain

25.0%

COVID-19 declared a
Pandemic

2.0%

Belarus

20.0%
15.0%

1.0%

COVID-19 declared a
Pandemic

10.0%
5.0%

0.0%
Dec 2019

Mar 2020

Mar 2021

Jun 2022

0.0%
Dec 2019

Dec 2021

Jun 2022

30.0%

3.0%

Italy

Mar 2020

COVID-19 declared a
Pandemic

Ukraine

2.0%

25.0%

20.0%

15.0%
COVID-19 declared a
Pandemic

1.0%

10.0%

5.0%

0.0%
Dec 2019

Mar 2020

Dec 2021

Jun 2022

0.0%
Dec 2019

International Cost of Capital Module | https://www.kroll.com/en/cost-of-capital/international-cost-of-capitalMar 2020

Dec 2021

Jun 2022

78

Takeaways of Today’s Presentation
Record high inflation is profoundly changing key value drivers:– Projected Growth Rates and operating margins– Discount Rates
Need to adjust cash flow projections for information known as of the valuation date:– Use multiple sources of data, particularly when there is a heighted level of uncertainty– Scenario Analyses will likely be a better way to capture some of that uncertainty.
– Discount rates cannot solve all the issues
Interest rates of safe-haven countries are still relatively low from an historical perspective, but are rising rapidly andsignificantly due to Central Banks actions in their attempt to tame inflationary pressures. Cost of debt is increasing accordingly.
Equity Risk Premium is cyclical– Historical measures are countercyclical and used without further adjustments may lead to the wrong conclusion
Betas for certain industries may be distorted
Country Risk changes over time to reflect current economic and market conditions
79

Extra Resources

Risk-Free Rate Normalization – Canada
As of Sept 15, 2022

-0.6%

Long-term Real Rate

+
2.6%

+
Long-term Expected Inflation

3.0%

=

=
2.0%

2.0%

Long-term Normalized Risk-Free Rate

5.0%

•

Fisher Equation: Midpoint = 3.5% / Median = 3.8%•

LT Average: 10-Year Trailing Average of Canada Benchmark Bond Yields – Long Term = 2.2%

Concluded Normalized Rf = 3.5%
81

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