Let's analyze the Mechanism of Growth. Well, the idea is very simple. I would, let's say this is our asset or lead box at point zero, and then there is some profit made in E1 I'll put it here and this is EPS1, so this is Earnings Per Share. And this amount many things can happen to this amount. And the first case well, we'll put it like Case1. All EPS1 is paid out as Dividend1 then, we know the answer and the price of the stock will be Dividend1, which is the same as EPS1, Divided by R, where R is the rate of return here. But, see what happens, if we paid that all out of then, this box at point one becomes exactly the same as it was point zero. So, this is the case of no growth. Therefore, we can say that for no growth, this piece of zero is equal to EPS1 divided by R that's what we wanted to find. Well, in order to proceed with some more interesting cases, we have to make some further assumptions. Let's say that we identify that the Return on Equity is EPS1 divided by Book Equity Per Share. So basically, we say that this box has constant cash generating capacity, if the box is like this, then it creates this one, if the box will be twice, that then EPS would be also twice the one put here. So, this is the internal capacity of casual generate, we will put that as constant. Now, now we can move on to the more interesting case two. In which we can say that, EPS1 can be used in two ways. Well, part of that can be payed out as Dividend1, and part of that can be reinvested as an investment at one. And if we divided that by EPS1 then, these are very well known quotients this called "Pay Out Rate" and that's called the "Plow Back Rate". And again, if we put these constant, then we can analyze the case of a constant growth. Well, strictly speaking, there may be some other cases. Let's analyze that too. We can think about case three, that let's say, Plow Back is not constant. So basically, this is the most realistic case that every year you reinvest at a different portion of your EPS. And then finally, to this we can add case four, which is "Borrowing". Because oftentimes, we would like to invest more than we have. So not only do we invest reinvest all EPS1, but we also borrow. And in this case, why do we borrow? Because we believed, that the return on our investment is greater than the cost of borrowing. And therefore using borrowed money we are able to create more value. Now, in what follows we go back to case two, and analyze this because this is the most interesting. So, we hold everything constant. And then, if G is the growth rate and that's actually the growth rate of Book Equity Per Share. Then, it can be shown that G is equal to return on equity, times the plow back. Well, clearly we are back to the Gordon's formula because, if this is constant, this is constant then, this has constant too. So we are now close to the analysis of what's going on here on the basis of these things held constant, but in order to proceed with that, we will go with their numeric example that although seems to be quite trivial, but actually will equip us with a very powerful tool in analyzing not only this sort of three or case two. But in the future also these more interesting cases three and four. That all in the next episode.
