Guidance: Discuss the purpose of the discount rate in the valuation process. You do not have to explain each of these components, but note that they assign risk to different categories of the company. The risk-free rate is what a company would earn on a riskless government security. The equity risk premium is the risk above the risk-free rate one should expect on an equity security. The industry premium is the risk associated with a particular industry (i.e. manufacturing or retail). The specific company risk is a subjective amount applied by the valuation analyst based on his or her perception of the company's risk. Company ABC Inc. Development of Discount Rate and Capitalization Rate Rate Note Risk-free long term U.S. Government bond rate 2.6 % (A) Equity risk premium 6.0 (B) Industry premium estimate 1.5 Specific company risk 3.0 Cost of equity (Discount rate) 13.1 Less: Long-term sustainable growth rate (2.5) Sum of (A) - (D) (E) Capitalization rate 10.6 % (A) Yield on the twenty-year U.S. Treasury bond as of December 31, 20XX, per the U.S. Treasury (B) Long-horizon expected return of large stocks over risk free securities, U.S. Equity Risk Premium (6.0%) (C) SIC code XX, 1.5% (D) Appraiser's judgement concerning company-specific risk (E) Estimated long-term growth rate based on inflation, Federal Reserve Bank of Philadelphia