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How to calculate "K"

deepak (Student CA Final ) (86 Points)

23 September 2012

Friends,

pls help me out to calculate K in this problem DDM model -dividend paid Re.1 expected to grow @ 20%for 5 yrs and 10% thereafter - AN Sridhar Pg 254 so formula will be

P= 1*(1.2)1 + 1*(1.2)2 + 1*(1.2)3+ 1*(1.2)4 + 1*(1.2)5+ 2.49(1+.10) * 1

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(1+k) (1+k)2 (1+k)3 (1+k)4 ( (1+k)5 ke-.10 (1+k)5

in the book they have simply said, solving by interpolation k = 18.10% hw to arrive at this

pls reply

thks in advance

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3 Replies

sneha (Chartered Accountant) (101 Points)
Replied 23 September 2012

i will try to explain you via steps

step 1: calculate P by taking k=18% the answer will come as P=20.22

step 2: calculate P by taking k=19% the answer will come as P=17.87

step 3: use formula of interpolation that is: lower rate + [(p of lower rate-desired p) / (p of upper rate-p of higher rate)] * (higher rate-lower rate)

in this case it vil b as follows: 18% + [(20.22-20) / (20.22-17.87)] * (19%-18%)

which is 18% + (0.22/2.35) * 1 wchich comes to 18.10%

as in exams we dont know k straightaway, so whtevr d value of k is taken if interpolation formula is applied properly the answer will come the same

i hope this helps

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deepak (Student CA Final ) (86 Points)
Replied 23 September 2012

thk u so much sneha..i've posted this two times no body replied..thks for explaining..

i didnt get one point..are u assuming k as 18% and 19% ?if yes how assuming??pls explain

thks in advance

sneha (Chartered Accountant) (101 Points)
Replied 24 September 2012

well there is no way to guess the accurate value of "k" at first tym itself....u have to use different rates in order to get nearest value to p n then use interpolation.

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