Gordon Growth Model (GGM)

(Question)Which of the following is NOT an input used to estimate a company's equity risk premium based on the Gordon Growth Model (GGM)?

A. Dividend yield on the market index.
B. Current long-term government bond yield.
C. Expected growth in the market index's P/E ratio.

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Answer: C

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The Gordon growth model calculates the equity risk premium by starting with the dividend yield on the market index, adding the consensus long-term earnings growth rate and subtracting the current long-term government bond yield. The expected growth in the market index's P/E ratio is an input used in the macroeconomic model.

P₀ = D₁/(r_e - g)

Equity risk premium = Dividend yield on the market index + Long-term earnings growth rate - Current long-term government bond yield