rate of return

(noun)

Rate of return (ROR), also known as return on investment (ROI), rate of profit or sometimes just return, is the ratio of money gained or lost (whether realized or unrealized) on an investment relative to the amount of money invested.

Related Terms

Examples of rate of return in the following topics:

  • Calculating the IRR

    • Given a collection of pairs (time, cash flow), a rate of return for which the net present value is zero is an internal rate of return.
    • Given a collection of pairs (time, cash flow) involved in a project, the internal rate of return follows from the net present value as a function of the rate of return.
    • A rate of return for which this function is zero is an internal rate of return.
    • Given the (period, cash flow) pairs (n, Cn) where n is a positive integer, the total number of periods N, and the net present value NPV, the internal rate of return is given by r in:
    • Because the internal rate of return on an investment or project is the "annualized effective compounded return rate" or "rate of return" that makes the net present value of all cash flows (both positive and negative) from a particular investment equal to zero, then the IRR r is given by the formula:

  • Defining the IRR

    • IRR is a rate of return used in capital budgeting to measure and compare the profitability of investments; the higher IRR, the more desirable the project.
    • The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investments.
    • It is also called the "discounted cash flow rate of return" (DCFROR) or the rate of return (ROR).
    • The internal rate of return on an investment or project is the "annualized effective compounded return rate" or "rate of return" that makes the net present value (NPV as NET*1/(1+IRR)^year) of all cash flows (both positive and negative) from a particular investment equal to zero.
    • Explain how Internal Rate of Return is used in capital budgeting

  • Advantages of the IRR Method

    • The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investment.
    • In other words, an investment is considered acceptable if its internal rate of return is greater than an established minimum acceptable rate of return or cost of capital.
    • In addition, the internal rate of return is a rate quantity, it is an indicator of the efficiency, quality, or yield of an investment.
    • Internal rate of return is the rate at which the NPV of an investment equals 0.
    • Describe the advantages of using the internal rate of return over other types of capital budgeting methods

  • The Capital Asset Pricing Model

    • It determines what the rate of return of an asset will be, assuming it is to be added to an already well-diversified portfolio, given that asset's systematic risk.
    • In real world applications, it enables us to determine whether or not a security is a worthwhile investment by comparing the expected rate of return of the security, given by the CAPM equation, with the actual rate of return.
    • The expected rate of return = the rate of return for a risk-free asset + beta* (the rate of return of the market - the risk-free rate).
    • The return of the market minus the risk-free rate is also known as the risk premium.
    • Calculate a company's expected rate of return using the Capital Asset Pricing Model (CAPM)

  • Return on Investment

    • One of the most common pricing objectives is obtaining a target rate of return on investment (ROI).
    • The purpose of the return on investment metric is to measure per period rates of return on dollars invested in an economic entity.
    • For example, this chart shows the rate of return on investments after training teachers.
    • Return on investment is often compared to expected (or required) rates of return on dollars invested.
    • This chart shows the rate of return on investments after training teachers.

  • Calculating and Understanding Average Returns

    • The average return of an investment can be calculated a number of ways.
    • To calculate the total ROI of an investment, simply divide the total dollar returns of the investment by the initial value.
    • Average ROI generally does not calculate the actual average rate of return, because it does not incorporate compounding returns.
    • CAGR is very useful for finding the rate of return that the investment would have to earn every year for the life of the investment to turn the initial value into the future value over the given time frame.
    • The internal rate of return (IRR) is another commonly used method for calculating the average return .

  • Return on Investment

    • The purpose of the "return on investment" metric is to measure per-period rates of return on dollars invested in an economic entity.
    • ROI is often compared to expected (or required) rates of return on dollars invested.
    • Return on investment = (gain from investment - cost of investment) / cost of investment
    • Complex calculations may also be required for property bought with an adjustable rate mortgage (ARM) with a variable escalating rate charged annually through the duration of the loan.
    • (To know more about ARM, check out: Mortgages: Fixed-Rate Versus Adjustable-Rate. )

  • Differences Between Required Return and the Cost of Capital

    • Required return refers to an investor's point of view, while cost of capital refers to the point of view of a company.
    • This can be relatively easily accomplished, since the mix of securities in the company's capital structure and the rates it pays on various forms of debt are known.
    • However, since required return is from the investor's point of view, it refers to the rate of return necessary to compensate investors for taking on the risk of the individual investment.
    • Instead of taking into account all types of securities issued by a firm, an investor acquires the appropriate required return by taking the risk-free rate and adding an investment specific risk premium.
    • It adds the risk-free rate to the risk premium of the market adjusted to an investment's beta.

  • Relationships between ROA, ROE, and Growth

    • Return on assets is a component of return on equity, both of which can be used to calculate a company's rate of growth.
    • In review, return on equity measures the rate of return on the ownership interest (shareholders' equity) of common stockholders.
    • In terms of growth rates, we use the value known as return on assets to determine a company's internal growth rate.
    • Return on assets gives us an indication of the capital intensity of the company.
    • Discuss the different uses of the Return on Assets and Return on Assets ratios

  • Percentage Returns

    • This type of return is also called the return on investment (ROI), where the numerator is the dollar return.
    • This is the arithmetic mean of the return.
    • CAGR is a way of measuring the return per year.
    • It is widely used because it allows for the easy comparison of the growth rates of multiple investments.
    • Another common method for finding the annual return is to calculate the internal rate of return (IRR).