Growth rate = Retention X Rate of actual return (what a company is earning)
i.e. by how much of amount, we'll earn more than current year.
e.g. earning 10% on Rs. 1lac (Rs. 10,000) & we are retaining whole profit, we are not paying dividend and we reinvest the amount in our business. What does it mean, that our invested capital is now more by Rs. 10,000.
So, in next year we'll earn 10% on Rs. [1lac(original capital) + 10K(reinvested profits of last year)] i.e. Rs. 11,000.
Now, how much we earned more than last year. Rs. 1,000, which is 10% of the amount retained & reinvested in the business (Rs. 10,000).
Here, opportunity cost can't be used, since OC is what you've already sacrificed so how can you earn that?!
Thats why we use actual rate of return i.e. what we'll earn by ourself (as 10% in above example).
And about practice manual, because of lack of information, it is assumed that entity is earning at the same rate of "what owners are expecting". Hence, Ke is used in that solution.
Hope you understand. Correct me if I'm wrong.
CAclubindia
