# Gordon growth model

given that we have all the available info to calculate the GGM, do we use bond yield + e(rp) or CAPM to calculate cost of equity? why do we choose one over the other?

Can you list a question where they gave you the information to calculate both bond yield + rp and CAPM, but they chose one over the other?

no, im just curious why there are 2 methods to calc ke.

I would think it would just be a matter of preference as they should theoretically produce the same answer. Although seeing as this is an unusual albiet interesting question, I don’t know the answer, I’m just guessing.

There is also the earnings yield plus some premium. You may not have all the information to calculate Ke from one of those formulas, so you just use whatever you have. Like black swan said, theoretically they should all be the same or close to it. If there is some variation, I would just take the average or decide which number I believe the best. The risk premium added to both earnings yield and bond yield are arbitrary numbers from what I was taught.

I think it has to do with why you might not like one calculation over the other. For example, what if your assumptions for estimating beta are flawed? Or you know that the beta you calculated is inaccurate? Then CAPM would be a poor estimate vs. the bond yield approach. On the test, they should only give you data to compute one or the other. I do not think we will need to choose which calculation to use between those two.

well, stalla used both and the by+erp approach is higher. im not sure whether it is because the value of the inputs made the answer higher or because there is a concept behind why it is higher. where’s numi?

Sure it depends on the inputs. If by using the CAPM, the beta was low like .85, then that would result in a smaller cost of equity. If we change the beta to 4.5 then our cost of equity skyrockets. As compared to the by+erp approach, the biggest change we can have is the (erp) which is usually below 5% I think.

4% to 6% is ringing a bell as to the E(rp).

wanderingcfa Wrote: ------------------------------------------------------- > I think it has to do with why you might not like > one calculation over the other. > > For example, what if your assumptions for > estimating beta are flawed? Or you know that the > beta you calculated is inaccurate? > > Then CAPM would be a poor estimate vs. the bond > yield approach. > > > On the test, they should only give you data to > compute one or the other. I do not think we will > need to choose which calculation to use between > those two. Wandering is right - the cost of equity can only be estimated, and there are a range of theoretical models to do so. Some are better than others depending on the circumstances. Ya puts some numbers in and see if it looks reasonable. On the test I suspect they will give all of the info necessary for only one method plus maybe part of the info for the others, just to confuse us.