Assume that the stock market index is trading at a level of 4,200. The long-term risk-free rate is 2%. The aggregate earnings of the firms in the stock market index are expected to be 180 next year and the payout ratio has been 33% and is expected to remain 33%.

Part A - What additional assumptions can justify the stock market index level of 4,200? Show your calculations and explain your reasoning carefully.

Part B - Suppose that the stock market index is fairly valued at 4,200 if the long-term risk free rate is 2%. Assume that the assumptions above still hold, including your additional assumptions that justify a level of the stock market index of 4,200. Now suppose that the long-term risk-free rate changes, but all the other assumptions that together with a long term risk-free rate of 2% justified the stock market index level of 4,200 stay the same.


Which level of the long-term risk-free rate would justify a decline of the stock market index level by 50% to 2,100?