1.2.1 THE GRINOLD–KRONER MODEL FORMULA IS E(R) = D/P ‒ ∆S +...

Section 3.1.2.1

The Grinold–Kroner model formula is

E(R) = D/P ‒ ∆S + i + g + ∆PE.

First, compute the compound annual growth rate of the P/E: (15.0/15.6)

^1/10

– 1 = ‒0.4%.

Next, compute, as a percentage, the expected return per the Grinold–Kroner model

formula:

E(R) = 2.1 ‒ (‒1.0) + 2.3 + 2.6 – 0.4 = 7.6,

where

E(R) = expected rate of return on equity

D/P = expected dividend yield

∆S = expected percent change in number of shares outstanding

i = the expected inflation rate

g = the expected real total earnings growth rate (not identical to EPS growth rate in

general, with changes in shares outstanding)

∆PE = per period percent change in the P/E multiple

4.) Using the data in Exhibit 3 and the investment team's approach to predict the Fed's next

move, the new fed funds rate will most likely be:

A. 2.9%.

B. 2.1%.

C. 2.6%.

Answer = B

“Capital Market Expectations,” John P. Calverley, Alan M. Meder, Brian D. Singer, and

Renato Staub