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The required rate of return is the minimum return an investor needs to justify the risk of an investment, while the expected rate of return is the return that an investor anticipates receiving based on their analysis of the investment's potential performance.

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What is profitability analysis?

An analysis of costs and revenue to determine whether or not a venture will make a profit, and, if so, how much. This is important information in deciding on whether to make an investment. The length of time required to repay the initial investment can be a critical factor.


How can one determine the required rate of return for an investment?

The required rate of return for an investment can be determined by considering factors such as the risk level of the investment, the current market interest rates, and the investor's own financial goals and risk tolerance. This rate is typically calculated based on the expected return needed to compensate for the risk taken on by investing in a particular asset.


How can a break-even analysis can help an entrepreneur planning to launch a business?

It tells the entrepreneur how long it will take to regain the initial investment of capital, giving potential investors an idea of when they will begin to see profits on their investment, and it also helps determine how much initial seed capital will be required to get the business up and running and financed until enough profit can be produced for the business to become self-sustained.


How can a break even analysis can help an entrepreneur planning to launch a business?

It tells the entrepreneur how long it will take to regain the initial investment of capital, giving potential investors an idea of when they will begin to see profits on their investment, and it also helps determine how much initial seed capital will be required to get the business up and running and financed until enough profit can be produced for the business to become self-sustained.


Determinants of required rates of return?

In this section, we continue our consideration of factors that you must consider when selecting securities for an investment portfolio. You will recall that this selection process involves finding securities that provide a rate of return that compensates you for: (1) the time value of money during the period of investment, (2) the expected rate of inflation during the period, and (3) the risk involved. The summation of these three components is called the required rate of return. This is the minimum rate of return that you should accept from an investment to compensate you for deferring consumption. Because of the importance of the required rate of return to the total investment selection process, this section contains a discussion of the three components and what influences each of them. The analysis and estimation of the required rate of return are complicated by the behavior of market rates over time. First, a wide range of rates is available for alternative investments at any time. Second, the rates of return on specific assets change dramatically over time. Third, the difference between the rates available (that is, the spread) on different assets changes over time. First, even though all these securities have promised returns based upon bond contracts, the promised annual yields during any year differ substantially. As an example, during 1999 the average yields on alternative assets ranged from 4.64 percent on T-bills to 7.88 percent for Baa corporate bonds. Second, the changes in yields for a specific asset are shown by the three-month Treasury bill rate that went from 4.64 percent in 1999 to 5.82 percent in 2000. Third, an example of a change in the difference between yields over time (referred to as a spread) is shown by the Baa-Aaa spread.4 The yield spread in 1995 was only 24 basis points (7.83 - 7.59), but the spread in 1999 was 83 basis points (7.88 - 7.05). (A basis point is 0.01 percent.) Because differences in yields result from the riskiness of each investment, you must understand the risk factors that affect the required rates of return and include them in your assessment of investment opportunities. Because the required returns on all investments change over time, and because large differences separate individual investments, you need to be aware of the several components that determine the required rate of return, starting with the risk-free rate. The discussion in this series of posts considers the three components of the required rate of return and briefly discusses what affects these components

Related Questions

What is profitability analysis?

An analysis of costs and revenue to determine whether or not a venture will make a profit, and, if so, how much. This is important information in deciding on whether to make an investment. The length of time required to repay the initial investment can be a critical factor.


What is the rule 72 used for?

Rule 72 is a simple formula used to estimate the number of years required to double an investment based on a fixed annual rate of return. By dividing 72 by the expected annual return percentage, investors can quickly gauge how long it will take for their investment to grow. For example, at an 8% return, it would take approximately 9 years to double the investment (72 ÷ 8 = 9). It's a handy tool for financial planning and investment analysis.


How can one determine the required rate of return for an investment?

The required rate of return for an investment can be determined by considering factors such as the risk level of the investment, the current market interest rates, and the investor's own financial goals and risk tolerance. This rate is typically calculated based on the expected return needed to compensate for the risk taken on by investing in a particular asset.


Can the word expected the same as required?

The word "expected" is not the same as "required". Something that is "expected" is something that is assumed will occur. Something that is "required" is something that is essential.


Is a rental property investment analysis required?

It is not required, but certainly recommended so you buy the best properties in your area that will attract good renters, and still maintain an income for you given the local rent levels etc


For markets to be in equilibrium the expected rate of return must be what?

For markets to be in equilibrium, the expected rate of return must equal the required rate of return. This means that investors are neither incentivized to buy nor sell an asset because the potential returns align with their risk tolerance and investment goals. When the expected returns diverge from the required returns, it leads to market adjustments until equilibrium is restored.


The cost of equity and the required rate of return are equal to what?

The cost of equity is the return that investors expect for holding a company's equity, reflecting the risk of the investment. The required rate of return is the minimum return an investor expects to earn from an investment, compensating for its risk. In essence, the cost of equity and the required rate of return are equal as they both represent the expected return that justifies the risk taken by investors in equity securities.


What is the Pay Back Method?

The Payback Method is a financial analysis tool used to evaluate the time required to recover an investment from its cash inflows. It calculates the period needed for an investment to "pay back" its initial cost, providing a simple metric for assessing risk and liquidity. While it is straightforward and easy to calculate, it does not account for the time value of money or cash flows that occur after the payback period, which can limit its effectiveness in comprehensive investment analysis.


What does unethical mean and some examples of it?

not working as per required, or expected to work not working as per required, or expected to work


What will increase the present value of an investment?

The present value of an investment can be increased by a higher expected future cash flow, a lower discount rate, or a shorter time period until those cash flows are received. Additionally, reducing risk associated with the investment can result in a lower required return, thereby increasing its present value. Diversifying the investment to mitigate risk can also enhance its attractiveness and perceived value.


What is the difference between energy investment phase and energy payoff phase?

The energy investment phase refers to the initial energy input required to start a process, such as plant growth or a workout. The energy payoff phase is when the system begins to produce a net gain in energy output, surpassing the initial investment.


What are the three basic factors that influence the required rate of return for an investor?

The three basic factors that influence the required rate of return for an investor are the risk-free rate of return, the expected return from the investment, and the risk premium associated with the investment. Investors typically demand a higher rate of return for riskier investments.

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