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Sfm - portfolio management

Nirav (Accountant) (595 Points)

22 June 2015

Hello, I have one query in a sum from AN Sridhar, in Portfolio management, Question no.15 (Raman ltd). Here in question avg share price of current year and proposed share price of next 3 years are given. Current share price is 370, next three years share price are 326, 294, 278 respectively. They have found g = avg annual capital gain by equation as 278 (1+g) raise to 3=370. And by solving they got g=10%. Please tell me how it is 10%. and why they used such equation to find g??

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CA. Sunil Gokhale (Teacher) (1484 Points)
Replied 22 June 2015

If an investment grows from Rs.278 to Rs.370 in n years then the compounded growth rate g can be computed as follows: 278(1+g)^n = 370. Therefore,

278(1+g)^3 = 370

(1+g)^3 = 370/278

(1+g)^3 = 1.331

Refer tables which give compounded value of Re.1 at 'x' rate of interest for 'n' years. For 3 years the factor 1.331 appears in the column for 10%. Hence, growth rate is 10%.

If the factor did not match exactly but fell between two rates then we can compute the exact rate by interpolation method exactly like we do for IRR. For example, the calaculation above came to 1.314. From the table we find that compounded value of Re.1 for 3 years at 9% is 1.295 & at 10% is 1.331 then we know that the growth rate is between these two rate. We then use the interpolation method (short-cut) to find the exact rate.