SS.11. Reading 33. BB. Ex.16.
Could someone explain me the denominator after they introduce rho…
I think you meant reading 32.Problem says the company has no real earnings growth so growth can only come from inflation.Denominator for DDM is r-g.Since the only earnings growth comes from inflation the denominator becomes r-I… (Because I= fake ass growth)…
What good is inflation to a firm if you cant pass along the costs to the customers?..
Rho is the percentage of inflation that the company can pass on to customers, hence increasing revenue…
For example…
If inflation is 4 and r is 8, your denominator would be 8-4=4 if you can pass on all the inflation to the customers…
But if you can only pass on 50% of it, your Rho is .5 and your denominator would be 8 - (.5)(4) = 6…
If inflation is your only source of growth and you can only pass on half the inflation to the consumer, you will only grow at half of inflation…
EDIT: Read the thing wrong, got Rho mixed up with the other squiglly thing. Long day at work and its late and frankly im tired.
Rho is just r-I. So replace my example above with Rho whenever you see r-I
I think you mean what happens in terms of Algebra after rho is introduced (correct me if I am wrong).
Simply (as AnalystDude123 suggested also) replace rho in that denominator with r-I, you’ll have in the denominator:
rho +(1-lambda)I= r-I +(1-lambda)I= r-I +I-lambda*I=r-lambda*I
the last part shows you that nothing changed from the previous step, you just added I and subtracted I
Thanks