If thecurrentrisk-freerate is 6 percent, this willyieldan
equity risk premium of 3 percent.
Thisapproachcanbegeneralizedtoallowforhighgrowthfor
aperiodandextendedtocovercashflow-based,ratherthan
dividend-based,models.Toillustratethis,considertheS&P
500 indexonJanuary1,2006.Theindexwasat1,248.29and
thedividend yieldon theindexin 2005 was roughly 3.34
percent.
21 In addition, the consensus estimate
22 of growth in earningsfor companies in theindex was
approximately 8 percent for the next five years, and the
10-year Treasurybond rate on January 1, 2006, was 4.39
percent.Sinceagrowthrateof 8 percentcannotbesustained
forever,weemployatwo-stagevaluationmodel,where we
allowdividendsandbuybackstogrowat 8 percentforfive
yearsandthenlowerthegrowthratetotheTreasurybondrate
of 4.39 percent after the five-year period.
23 Table2.3summarizestheexpectedcashflowsforthenext
fiveyearsofhighgrowthandthefirstyearofstablegrowth
thereafter.
TABLE 2.3Expected Cash Flows on S&P 500
YearCash Flow on Index
1 44.96a
2 48.56
3 52.44
4 56.64
5 61.17
6 61.17(1.0439)