Company specific risk premium
DCFAn increment to the cost of equity for risks particular to one company, and the most common source of double counting in a discount rate.
Also written: company specific premium, specific risk premium
A company specific risk premium is an amount added to the cost of equity for something true of this business and not of businesses generally: one customer taking most of revenue, a founder who is the entire commercial relationship, a single production site, one regulator with the power to end the model.
Stacked on top of a size premium it usually double counts, and the reason is structural rather than careless. A size premium is an average, across small companies, of exactly these features. Thin management depth and concentrated customers are not incidental to being small, they are what makes small companies riskier, and they are what the premium measured. Charge the average and then charge a named instance of the average and one risk has been priced twice. The test is not whether the risk is real, it is whether it is unusual for a company of this size.
The second half of the discipline is deciding what does not belong in a rate at all. A discount rate prices risk that is continuing, and it applies to every forecast year and to the terminal value behind them. A contract that may not be renewed in eighteen months is an event with a probability, and events belong in the cash flows as a weighted case or an explicit downside. Charging it in the rate charges it forever, including the years after the contract would have been replaced.
The practical fix is a list. Under each premium, write the specific risks it is being charged for. If a risk appears under both, delete it from one. If the whole company specific list turns out to be a description of being small, there is no company specific premium left to add. Doing that out loud is worth more in an interview than any particular number, because it presents the discount rate as a place where judgement is expressed rather than where adjustments accumulate.
Worked example
Illustrative. A CAPM cost of equity of 9.6%, plus 3 points of size premium, plus 2 points for customer concentration and thin management depth, gives 14.6%.
On cash flow growing at 2% forever, the 14.6% rate leaves about 60% of the value the 9.6% rate gave. If 1.5 of those last 2 points describe risks already inside the size premium, the defensible rate is 13.1% and the value is about 68%.
So the double count alone destroys roughly an eighth of the equity. That is not conservatism. It is an error with a direction, and it is the first thing a reviewer looks for.