How to Calculate a Premium

••• Hemera Technologies/AbleStock.com/Getty Images

Buyer perception forms premiums. A premium creates a market value for any material item, good or service. A reason why you might pay a premium is that you believe an item will continue to increase in value. When a business pays above book value, it is paying a premium. A company can pay $20 million for a target company worth only $10 million, which is a $10 million premium above book value.

Figure out the cost basis. This is what the item is currently worth based on market value, the selling price or asking price. In stock investing, the market value will be the stock price.

Decide how much you are willing to pay. It you are only willing to pay the going market rate, then there is no premium and no need for the calculation. However, if you believe the item is or will be currently worth more later than what it is selling for today, you need to set a price target above the selling price.

Take the difference in what you paid for the item and the market or asking price. The amount that you paid above the asking price is the premium. For example, if a rare coin is selling for $300 but you believe it is worth more, you might pay a premium if a competing offers a made on the coin. If you pay $400 for it, then you paid a $100 premium.

Calculate the premium in percentage terms. In order to do this, you need to take the difference between how much you paid and the asking price divided by the asking price multiplied by 100. In this case, you paid a 33 percent premium ((400 - 300)/ 300 * 100).

Tips

  • Stock analysts compare how cheap or expensive a stock is by looking at its price-to-earnings (P/E) ratio. To calculate the P/E ratio take the current stock price and divide it by forecast or actual earnings per share. For example, a stock is trading at a premium at 15 times its earnings compared to an industry average of 10 times earnings. This signifies that investors believe that the stock is actually worth more than comparative companies. As more investors pile into the stock, the price will continue to increase relative to its peer group. These investors are willing to pay a premium for the shares based on their perceptions of the company.

References

Photo Credits

  • Hemera Technologies/AbleStock.com/Getty Images