Abstract
Practitioners commonly augment the CAPM cost of equity by adding the Size Premium in Excess of CAPM published in the Ibbotson and Duff & Phelps yearbooks. However, the empirical evidence following Banz’s paper in 1981 does not support the existence of a size premium. Moreover, even if a size premium is deemed to be warranted, the Size Premium in Excess of CAPM as calculated by Ibbotson and Duff & Phelps are inconsistent with the CAPM cost of equity estimated by valuation practitioners and it also does not appropriately measure the size premium applicable in a DCF analysis. Therefore, adding the Size Premium in Excess of CAPM is no different than adding an arbitrary number to the CAPM cost of equity. In this paper, I provide an illustration of how to calculate a Practitioner-Consistent Size Premium to potentially resolve these issues. However, the results of that analysis yields unreliable results.
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