GGM estimate of equity risk premium...

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CFA.Rhythm

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Question: The GGM estimate of equity risk premium is closest to:
A. 4.5%
B. 4.67%
C. 7.25%
stock price = 30
SP growth rate = 6.75%
Current level of SP index = 1200
Long term government bond = 4.75%
 
I have no idea. I feel like a dividend would be needed to use the regular GGM or multiperiod cash flow rates would be needed to use the equity index price GGM.
Either way, I’m stumped.
 
d1/P +g = r
x/30 + .0675=r
r = rf + ERP
so ERP = r - .0475
so x the dividend is missing….
 
Has to be C. The required equity return (r) always has to be greater than the growth rate (g), for some reason that Schweser never elaborates on.
 
Reading 41, page 348, #19
I’ve never seen this formula, and I was totally stumped. I wanted to see what some other people’s reactions were.
Answer:
30(1.065) / 1200 + .0675 - .0475 = .0467 (answer B)
I had no idea that we can use GGM to compute equity risk premium, but by using this formula, we can.
 
Because otherwise you cannot use the DDM model (P0=div1/(r-g)), there is no such thing as negative price of a stock.
 
I had given and derived the formula above. also in your problem above, you had not said Stock dividend = 30. you said stock price - which threw us off.
look at the formula for the GGM:
P=D1/(r-g)
so
D1/P = r-g
or r = D1/P + g
and r = rf + ERP
so you have it.
 
You are right. My mistake. It’s late for me (central europe time), and these are my last questions of the night.
Yes, the dividend = 30, not the stock price
I guess it’s: D1/P + g - rfr
 
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