Grinold Kroner Model- Practice Problem

CFA Level III Equities
#1
  • 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.

#2

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.

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#3

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:

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