Question $4(6\mathrm{.}5$ points$)$

To compute the implied equity risk premium $($ERP$),$ one input that you need is the expected growth rate in earnings$/$cash flows in future years. That input can be estimated by looking at analyst estimates of growth in earnings for individual companies, but there are studies that indicate that these estimates are biased upwards. Assuming that these growth rates are biased upwards, what effect will it have on your computed ERP?

Hint: Stock price $($intrinsic value$)=C\frac{F_1}{r-g}$ and implied equity risk premium $(ERP)=r-$risk$-$ free rate

You will over estimate the implied ERP

You will under estimate the implied ERP

You could under or over estimate the implied ERP