FINANCE

Rate of Return.

The Rate of Return is measure of investment performance. A simplified definition of conception learning is…

= the percentage earned on the capital invested over a given invested and (typically per annum).

= Profit or Loss/Capital invested and therefore can be +tive/-tive.

Let’s explore some examples where rates of return can be used to measure and identify the better investment using EXCEL…

The Return, what you earn on an investment, is measured as a rate or percentage as this makes the measure independent of scale. Investments of different scale, size or capital can be compared by percentage. A 10% rate of return on $100 is better than a 1% rate of return on $1,000.

Required rate of return

How does a (RRoR) of 5%, which arises from raising $100 of capital, affect the Investment decision, aka how does having to pay 5% for capital, affect the choice of assets that the company buys with the capital?

Liabilities/Debt = $50

equity = $50

Overall Cost of Capital = 5%

Why?… using a Weighted Average of the above 2 components of capital

50/100 x 5%+50/100 x 5%=5%

This is called the weighted average cost of capital or WACC.

This is a Required Rate of Return (RRoR)

If the company does not pay 5% to it’s financiers, it cannot continue it’s business.