The S&P 500 index stood at 1271 in early 2006. Based on analysts' consensus EPS forecasts for

Question:

The S&P 500 index stood at 1271 in early 2006. Based on analysts' consensus EPS forecasts for calendar year 2006, the forward P/E ratio for the index was 15.0 at the time. Those same analysts were giving the S&P 500 a PEG ratio of 1.47, based on forecasts for 2007. The payout ratio for this portfolio of stocks was 27 percent at the time and investment banks typically published estimates of the equity risk premium of 5 percent over the current 10-year Treasury rate of 5 percent.

a. Calculate the abnormal earnings growth for2007thatis implied by the forecasts.

b. What should be the level of the S&P 500 if (cum-dividend) earnings are forecasted to grow at 10 percent after the forward year? Why is the P/E based on analysts' forecasts different?

c. Setting the long-term abnormal earnings growth rate equal to 4 percent (the average growth rate for GDP), what do analysts' forecasts say about the level of the S&P 500 index?

d. What conclusions can your draw from this analysis?

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