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Hello John.
I have watched the lectures and am now going through a revision kit.
could you help me understand the logic of this?:
method of calculating a previous growth rate ‘g’ (e.g. in revenue) –
(most recent rev/earliest rev)^-1/y – 1. (*’y’ denotes number of years to present, ^ denotes ‘to the power of’).
e.g. if revenue in year one is 100 and in year three (most recently) is 1000, then we have:
(1000/100)^-1/3 – 1.
I think you mentioned in the lecture that the power of -1/3 is due to geometric averages.
but what is the meaning/relevance of subtracting 1 ( – 1) ? why do we do that?
I will explain with an example.
Suppose something is growing at 10% per year.
Then if you start with $100, after one year is will grow to 100 x (1.10). After two years it will grow to 100 x (1.10)^2, and after three years it will grow to 100 x (1.10)^3.That means it will have grown to 133.10
Now suppose instead that you were told that the revenue now is 133.10 and it was 100 three years ago and you were asked to calculate the average annual growth rate.
If r is the annual growth rate, then 100 x (1+r)^3 = 133.10
Therefore (1+r)^3 = 133.10/100 = 1.331
Therefore 1+r = the third root of 1.331, which is the same as (1+ 0.331)^1/3
(You should know from school that writing something as to the power 1/3 is a way of typing the third root).This is all revision from Paper FM (was F9) so if you are still not clear it will help you to watch the relevant Paper FM lectures.
wow, ok i see clearly now. then you move the 1+r to the other side of the equal sign so it becomes -1.
thank you John! that is a very clear explanation, i appreciate it.
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