aCash flow in the first year = 3.34% of 1,248.29(1.08)
Ifweassumethatthesearereasonableestimatesofthecash
flows and that the index is correctly priced, then:
Notethatthelasttermoftheequationistheterminalvalueof
theindex,basedonthestablegrowth rateof4.39percent,
discountedbacktothepresent.Solvingforrinthisequation
yields the required return on equity of 8.47 percent.
SubtractingouttheTreasurybondrateof4.39percentyields
an implied equity premium of 4.08 percent.
Theadvantageofthisapproachisthatitismarket-drivenand
currentanditdoesnotrequireanyhistoricaldata.Thus,itcan
beusedtoestimateimpliedequitypremiumsinanymarket.It
is, however, bounded by whether the model used for the
valuationistherightoneandtheavailabilityandreliabilityof
theinputstothatmodel.Forinstance,theequityriskpremium
fortheBrazilianmarketinJune 2005 wasestimatedfromthe
followinginputs.Theindex(Bovespa)wasat26,196andthe
current dividend yield on the index was 6.19 percent.
Earningsincompaniesintheindexwereexpectedtogrow 8
percent (inU.S. dollarterms)over thenextfiveyearsand
4.08percentthereafter.Theseinputsyieldarequiredreturn
on equity of 11.66 percent, which when compared to the
Treasurybondrateof4.08percentonthatdayresultsinan
impliedequitypremiumof7.58percent.Forsimplicity,we
have used nominal dollar expected growth rates