Size Premium
A size premium is an additional return added to the cost of equity in a Discounted Cash Flow (DCF) analysis to account for the higher risk associated with investing in smaller companies, which tend to have more volatility and limited access to capital compared to larger firms.
Example
Let’s say you use the CAPM to analyze a business in the AI industry and you come up with a Cost of Equity (Coe) of 14%. Now, you think about how much smaller your company is that most pubic companies and add a Size Premium of 2%. Now your updated Cost of Equity is 16% (14% + 2%).
In the room
A practical adjustment that shows you understand the limits of textbook CAPM. Smaller companies carry more risk than a beta derived from large public comps implies, so you add a premium to compensate.