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Rate Of Return

What is a 'Rate Of Return'

A rate of return is the gain or loss on an investment over a specified time period, expressed as a percentage of the investment’s cost. Gains on investments are defined as income received plus any capital gains realized on the sale of the investment. Rate of return can also be defined as the net amount of discounted cash flows received on an investment.

Explaining 'Rate Of Return'

A rate of return can be applied to any investment vehicle, from real estate to bonds, stocks and fine art, provided the asset is purchased at one point in time and produces cash flow at some point in the future. Investments are assessed based, in part, on past rates of return, which can be compared against assets of the same type to determine which investments are the most attractive.

The Differences Between Stocks and Bonds

The rate of return calculation for stocks and bonds is slightly different. Assume an investor buys a stock for $60 a share, owns the stock for five years, and earns $10 in total dividends. If the investor sells the stock for $80, he has a $20 per share gain and has earned another $10 in income. The rate of return for the stock is $30 per share divided by the $60 cost per share, or 50%.

How to Discount Cash Flows

Discounted cash flows take the earnings on an investment and discount each of the cash flows based on a discount rate. The discount rate represents a minimum rate of return acceptable to the investor, or an assumed rate of inflation. In addition to investors, businesses use discounted cash flows to assess the profitability of a company's investment.


Further Reading


Electricity economics: Essays and case studies
www.osti.gov [PDF]
… The chapters following an introductory chapter are Economics, Finance, and Equity in Tariff Policy; Electricity Tariffs in Thailand; Electricity Tariffs … Electricity Development in Turkey: A Case Study Using Linear Programming; How to Study Tariffs; The Rate of Return on Projects …

Pricing rate of return guarantees in a Heath–Jarrow–Morton frameworkPricing rate of return guarantees in a Heath–Jarrow–Morton framework
www.sciencedirect.com [PDF]
… The chapters following an introductory chapter are Economics, Finance, and Equity in Tariff Policy; Electricity Tariffs in Thailand; Electricity Tariffs … Electricity Development in Turkey: A Case Study Using Linear Programming; How to Study Tariffs; The Rate of Return on Projects …

Solving fuzzy equations in economics and financeSolving fuzzy equations in economics and finance
www.sciencedirect.com [PDF]
… The chapters following an introductory chapter are Economics, Finance, and Equity in Tariff Policy; Electricity Tariffs in Thailand; Electricity Tariffs … Electricity Development in Turkey: A Case Study Using Linear Programming; How to Study Tariffs; The Rate of Return on Projects …

PE ratios, PEG ratios, and estimating the implied expected rate of return on equity capitalPE ratios, PEG ratios, and estimating the implied expected rate of return on equity capital
meridian.allenpress.com [PDF]
… The chapters following an introductory chapter are Economics, Finance, and Equity in Tariff Policy; Electricity Tariffs in Thailand; Electricity Tariffs … Electricity Development in Turkey: A Case Study Using Linear Programming; How to Study Tariffs; The Rate of Return on Projects …

Investment evaluation methods and required rate of return in Finnish publicly listed companiesInvestment evaluation methods and required rate of return in Finnish publicly listed companies
papers.ssrn.com [PDF]
… The chapters following an introductory chapter are Economics, Finance, and Equity in Tariff Policy; Electricity Tariffs in Thailand; Electricity Tariffs … Electricity Development in Turkey: A Case Study Using Linear Programming; How to Study Tariffs; The Rate of Return on Projects …

Exposure to exchange-rate movementsExposure to exchange-rate movements
www.sciencedirect.com [PDF]
… The chapters following an introductory chapter are Economics, Finance, and Equity in Tariff Policy; Electricity Tariffs in Thailand; Electricity Tariffs … Electricity Development in Turkey: A Case Study Using Linear Programming; How to Study Tariffs; The Rate of Return on Projects …

The application of finance theory to public utility rate casesThe application of finance theory to public utility rate cases
www.jstor.org [PDF]
… The chapters following an introductory chapter are Economics, Finance, and Equity in Tariff Policy; Electricity Tariffs in Thailand; Electricity Tariffs … Electricity Development in Turkey: A Case Study Using Linear Programming; How to Study Tariffs; The Rate of Return on Projects …

The economics of security divisibility and financial intermediationThe economics of security divisibility and financial intermediation
www.jstor.org [PDF]
… The chapters following an introductory chapter are Economics, Finance, and Equity in Tariff Policy; Electricity Tariffs in Thailand; Electricity Tariffs … Electricity Development in Turkey: A Case Study Using Linear Programming; How to Study Tariffs; The Rate of Return on Projects …

The rate of return on everything, 1870–2015The rate of return on everything, 1870–2015
academic.oup.com [PDF]
… The chapters following an introductory chapter are Economics, Finance, and Equity in Tariff Policy; Electricity Tariffs in Thailand; Electricity Tariffs … Electricity Development in Turkey: A Case Study Using Linear Programming; How to Study Tariffs; The Rate of Return on Projects …



Q&A About Rate Of Return


What is the definition of a rate of return?

A rate of return is the gain or loss on an investment over a specified time period, expressed as a percentage of the investments cost.

What does discounted cash flow mean?

Discounted cash flows take earnings on an investment and discount each of the cash flows based on a discount rate which represents minimum acceptable returns or assumed inflation rates."

How can you calculate the rate of return for stocks and bonds?

The calculation for stocks and bonds are slightly different. For stocks, assume an investor buys a stock for 6 per share, owns it for five years, and earns 1 in total dividends. If he sells it for 8 per share, he has a 2 per share gain and has earned another 1 in income. The rate of return for the stock is 3 divided by 6 or 5%. For bonds, assume an investor purchases a bond at par value with coupon payments every six months. Assume that each payment is worth 4 dollars when received but only 3 dollars when paid back to investors at maturity. The discount rate used to calculate this bond's yield-to-maturity should be equal to its required annual interest rate (coupon/2). In this example, if we use 10% as our discount rate then we would receive 10% on each coupon payment received and pay back 10% on each coupon payment paid out at maturity.""

Why do businesses use discounted cash flow analysis?

Businesses use discounted cash flows to assess profitability."

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