# Reading 41 Q19 and Q20 CFAI

Could someone explain the answer to these? I’m close, but I don’t understand it from the CFAI explanation. 19. Current level of S&P index = 1200 Current dividend on the S&P index is 30 Long term US gov bond yield = 4.75% Future earnings growth rate of the S&P index = 6.75% The Gordon growth model estimate of the equity risk premium is: A. 4.50% B. 4.67% C. 7.25% 20. Current E/S is 2.40 Current stock price is 20 Return on book equity is 12% Sustainable growth rate = 4% The estimate for PVGO for the company is closest to: A. \$5 B. \$9 C. \$11

Bradleyz Wrote: ------------------------------------------------------- > Could someone explain the answer to these? I’m > close, but I don’t understand it from the CFAI > explanation. > > 19. > > Current level of S&P index = 1200 > Current dividend on the S&P index is 30 > Long term US gov bond yield = 4.75% > Future earnings growth rate of the S&P index = > 6.75% > > The Gordon growth model estimate of the equity > risk premium is: > > A. 4.50% > B. 4.67% > C. 7.25% > > 20. > > Current E/S is 2.40 > Current stock price is 20 > Return on book equity is 12% > Sustainable growth rate = 4% > > The estimate for PVGO for the company is closest > to: > > A. \$5 > B. \$9 > C. \$11 19: 30*1.0675/1200 + .0675-.0475 = .0467. B 20: 2.4/.12 = 20. … u sure the current price is 20?

1. P=1200 D=30 rf=4.75 D1=D0(1+g) = 30*(1.0675) D1/(r-g) = P0 so r = D1/P0 + g = 30(1.0675)/1200 + 6.75 = r = 9.42% r = rf+ERP=4.75+ERP ERP = 9.42 - 4.75 = 4.67% Ans B

so many ways for this one: I used 1200 = (30*10.615)/[(0.0475 + ERP) - 0.0675] and solved for ERP, getting 0.0465

Yes, like CFABLACKBELT, I am also getting PVGO = 0, if the stock price is 20.

Me three.

the only way get one of the answers in the second question is to add the SGR and the return on book equity then PVGO = 20 - 2.40/0.16 = 5 But that doesn’t seem correct

19.) B 20.) only answer I can come with that is a choice is 11 2.4(1.04)/.08 =31.2 - current price of 20 is 11 makse no sense though, should be 0.

maybe this way: P = D1/(r - g) so 20 = 2.40(1.04)/(r - 0.04) 20r - 0.8 = 2.496 r = 0.1648 Then PVGO = 20 - 2.40/0.1648 = 5.43 which is closest to A

newsuper Wrote: ------------------------------------------------------- > so many ways for this one: > > I used > > 1200 = (30*10.615)/[(0.0475 + ERP) - 0.0675] > > and solved for ERP, getting 0.0465 Newsuper, where does 10.615 come from?

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Just an observation…aren’t you guys assuming 12% is the required return when the question states it is the ROE?

in the equity book - they do refer often to re as Return on equity.

cjones65 Wrote: ------------------------------------------------------- > newsuper Wrote: > -------------------------------------------------- > ----- > > so many ways for this one: > > > > I used > > > > 1200 = (30*10.615)/[(0.0475 + ERP) - 0.0675] > > > > and solved for ERP, getting 0.0465 > > > Newsuper, One more time. Where does 10.615 come from? Newsuper, anyone?

I don’t get the 10.615 either… I did: 1200 = (30 * 1.0675) / [(ERP + .0475) - (.0675)] Which turns into: ERP = [(30 * 1.0675) / (1200)] + .0675 - .0475 = .0467 or 4.67% ---- For the second question, I’m getting PVGO = 0… I don’t think the price is correct but who knows

I think he meant 1.0675 and it got mistyped as 10.615 instead.

people - in the PVGO equation the E which stands for earnings is E-sub-1 i.e. “expected” earnings. so, i come up with 20 - ((2.4)(1.04))/.12 = 20 - 20.8 = - .8. wierd. i tried to convert PVGO to P/E somehow but got lost.

sorry about my last post, E-sub-1 is wrong, its really just E/r. schweser’s quicksheet has it incorrectly lisetd as E-sub-1 / r. also, the answer for the first ERP question is A, and here’s how. i had also followed the regular GGM the first time, but then stumbled on this formula in the notes. ERP via GGM when doing so for an index = Dividend Payout + Long - Term Earnings Growth Rate - Long-term US govt bond yield dividend payout = 2.5% + earnings % = 6.75% + govt bond yield = 4.75% - ERP = 4.50%

so you dont use D1?

cjones65 Wrote: ------------------------------------------------------- > newsuper Wrote: > -------------------------------------------------- > ----- > > so many ways for this one: > > > > I used > > > > 1200 = (30*10.615)/[(0.0475 + ERP) - 0.0675] > > > > and solved for ERP, getting 0.0465 > > > Newsuper, where does 10.615 come from? yeah sorry it was a typo, should have been 1.0675