Question
On April 9th 2020, the S&P500 was trading at 2,750, implying a current P/E ratio of 18. The expected cash payout ratio (dividends + buybacks)
On April 9th 2020, the S&P500 was trading at 2,750, implying a current P/E ratio of 18. The expected cash payout ratio (dividends + buybacks) is 92% of earnings (in perpetuity). Analysts consensus annual growth forecast in earnings for the index is 3.5% for the next 5 years. Use a risk free rate of 0.8% and set the long term growth rate equal to the risk free rate. 1) Estimate the implied equity risk premium using a two-stage growth model given the current level of the S&P500 index and expectations of cash flows. 2) All else equal (i.e. for a given level of the S&P500 index), what would happen to the iERP if the COVID crisis led investors to lower substantially their expectations of dividends and buybacks? (Would it go up or down?)
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