Grinold Kroner Model- Practice Problem

  • The dividend yield will be 1.95%.
  • Shares outstanding will decline 1.00%.
  • The long-term inflation rate will be 1.75% per year.
  • An expansion rate for P/E multiples will be 0.15% per year.
  • The long-term corporate earnings growth premium will be 1% above expected real GDP growth.
  • Expected real GDP growth will be 2.5% per year.
  • The risk-free rate will be 2.0%.

The problem asked to calculate the equity returns using the Grinold Kroner method.

I got 7.35%. While the answer according to the CFA 8.35%
For expected earnings growth, I used 2.5% +1.75% while the CFA added also the 1%, but my logic was not to add the 1% because a company cannot grow more than the economy on the long term.

Keep in mind that this model accommodates short term forecasts so it’s possible earning growth rate surpasses long term GDP growth rates in the short run.

Greetings friend! A way to think of the G-K model in this scenario is:

Dividend yield + (expected inflation rate + real growth rate of earnings) - (share growth) + (P/E growth)

So it equals 1.95% + [1.75% + (2.5% + 1%)] - (-1%) + 0.15% = 8.35%

Cheers - good luck - you got this :+1: