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How do you calculate return on investment with uneven cash flows?
Wiki User
∙ 10y ago
It depends. ROI is often treated as a simple accounting measure independent of the time value of money (http://www.investopedia.com/terms/r/returnoninvestment.asp). By that definition, you just sum all of the cash inflows, deduct you're your outflows and the cost of your investment and divide by the cost of the investment.
A more interesting case is the IRR (internal rate of return). A single formula won't work. The general rule is to discount each period's cash flow. Sometimes people say ROI but mean IRR.
Say you expect to earn $1,000,000 at the end of year one and $10,000,000 at the end of year 20 on a $5,000,000 investment at the beginning of year one. Guess a rate of 5% as the IRR.
The net present value of the cash flows would be (using the Excel operator ^ to denote "to the power of"):
-$5,000,000 + $1,000,000/(1+5%)^1 + $10,000,000/(1+5%)^20 = -278,724
You have a negative balance, so try a slightly lower rate so the future purchasing power isn't eroded so much. If set up on Excel, you can easily point to a cell with your current guess.
The sum of the net present cash flows should equal zero if you have the right guess. It turns out that 4.63% is a close approximation for this stream of cash flows. At this rate, you would be indifferent in 20 years if you invested the $5,000,000 in a deposit account paying 4.63% interest and this investment (assuming you reinvest all earnings). You would have roughly $12,363,000 either way.
Wiki User
∙ 10y ago
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How do you calculate unadjusted rate of return with depreciation?
To calculate unadjusted rate of return with depreciation: Subtract depreciation cost from the expected cash flows along with expenses, then multiply the result by the income tax rate and subtract. Calculate average investment 10,000/2 Example: Machine Investment $10,000 4 year life , Expected cash flows 8,000 expenses 2,200 tax rate 20% (8,000-2,500-2.200) x (1 -.20) = 2,640/5,000 = 52.80%
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Method of investment appraisal which determines return on investment by totaling the cash flows (over the years for which the money was invested) and dividing that amount by the number of years.
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What method of evaluating capital investment proposals uses the concept of present value to compute rate of return?
The method that uses the concept of present value to compute rate of return is called the Net Present Value (NPV) method. In this method, the cash inflows and outflows of a capital investment proposal are discounted to their present value using a discount rate. The NPV is then calculated by subtracting the initial investment from the present value of the cash flows. A positive NPV indicates a profitable investment, while a negative NPV suggests an unprofitable investment.
What are the concepts return on investment?
Return on investment (ROI) is a financial metric used to evaluate the profitability of an investment relative to its cost. It is calculated by dividing the net profit from the investment by the initial cost of the investment, usually expressed as a percentage. A higher ROI indicates a more profitable investment.
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The difference between the amount of money received from selling an investment and the amount of money spent to purchase the investment its known as?
The difference between the amount of money received from selling an investment and the amount of money spent to purchase the investment is known as the capital gain or loss. When the capital gain or loss is then compared to the initial investment (through division), the result is the capital gains yield or return on investment (assuming there are no cash flows such as coupon payments or dividends).
Discounted payback method?
A discounted payback method is a formula that is used to calculate how long to recoup investments based on the discounted cash flows of the investment. It is a variation of payback period or the time it takes to recover a project investment given the discounted cash flow it has.
What are the differences between accounting rate of return and internal rate of return?
Internal rate of return (IRR) is a discounted method used for Capital budgeting decisions (investment etc) while accounting rate of retun is a measure for calculating return for a one off payment. IRR is actually the discount rate that equates the Present value of the cash flows to the NPV of the project (investment) while accounting rate of return just gives the actual rate of return. Habib topu1910@gmail.com
What is the meaning of the term net present value?
Net Present Value (NPV) means the difference between the present value of the future cash flows from an investment and the amount of investment.Present value of the expected cash flows is computed by discounting them at the required rate of return. For example, an investment of $1,000 today at 10 percent will yield $1,100 at the end of the year; therefore, the present value of $1,100 at the desired rate of return (10 percent) is $1,000. The amount of investment ($1,000 in this example) is deducted from this figure to arrive at net present value which here is zero ($1,000-$1,000).A zero net present value means the project repays original investment plus the required rate of return. A positive net present value means a better return, and a negative net present value means a worse return.
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What is meant by the abbreviation of IRR?
IRR stands for Internal Rate of Return. It is a financial metric used to measure the profitability of an investment. It represents the annualized rate of return at which the net present value of cash flows from an investment becomes zero.
