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Ibbotsen Chen Equity risk premium

Hey guys,

A little help here

For the Ibbotsen Chen model [(1+inflation)x(1+RealGDPGrowth)x(1+Changes in PE)-1] +Yield of Market

Am I subtracting the risk free rate at the end?

Granted, almost all my notes say to do so…. But then I came across notes from my TT’S and CFAI mocks that say not to include it. Now I’m confused.

Which one is right? Is there a situation where I would include it and one where I wont?

Thanks for the help

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Yes you would subtract the risk free rate if trying finding the equity risk premium. If you’re using Ibbotsen Chen for required return on equity, you would not subtract the risk free rate.

Beauty!!! Thanks buddy

Yes, subtract RFR, adding Market yield and subtract -1…

hope this doesn’t come up can never remember that formula

Its actually not that hard honestly… 

It wont be plug and chug - but could be more theorically based.  Also, they could trip you up making you calc the expected earnings growth estimate (ie: give you 2016 and 2017 results and make you infer what occured) and what that does in terms of the ERP within the Ibbotsen Chen formula.  just my 2cents