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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.
What else can I help you with?
Calculate the value of each investment based on your required rate of return?
To calculate the value of each investment based on your required rate of return, you can use the discounted cash flow (DCF) method. This involves estimating future cash flows from the investment and discounting them back to their present value using your required rate of return as the discount rate. The formula is: Present Value = Cash Flow / (1 + rate of return)^n, where n is the number of periods. Summing the present values of all future cash flows will give you the total value of the investment.
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%
What is the difference between the discount rate and the rate of return?
The discount rate is the interest rate used to calculate the present value of future cash flows, while the rate of return is the profit or loss on an investment over a specific period of time.
Definition of Average Rate of Return?
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.
3 main components of the capital account?
Debt flows, Foreign Direct Investment Flows and Portfolio Investment Flows
Is Depreciation deducted to calculate Internal rate of return?
No, depreciation is not deducted when calculating the Internal Rate of Return (IRR). IRR focuses on cash flows generated by a project or investment, and since depreciation is a non-cash accounting expense, it does not directly impact cash flow. Instead, IRR considers actual cash inflows and outflows over the investment's life to determine its profitability.
What are the differences between ROR and IRR and how do they impact investment decisions?
The main difference between ROR (Rate of Return) and IRR (Internal Rate of Return) is that ROR calculates the overall return on an investment, while IRR calculates the rate at which the net present value of cash flows equals zero. ROR is a simpler measure that shows the total return on an investment, while IRR takes into account the timing of cash flows and provides a more accurate measure of the investment's profitability. When making investment decisions, ROR helps investors understand the total return they can expect, while IRR helps in comparing different investment options by considering the time value of money. Investors often use both metrics to evaluate the potential returns and risks of an investment.
What is the difference between internal rate of return (IRR) and rate of return (ROR)?
The main difference between internal rate of return (IRR) and rate of return (ROR) is that IRR takes into account the time value of money and the timing of cash flows, while ROR does not consider these factors. IRR is a more precise measure of return on an investment, as it considers the entire cash flow timeline and calculates the discount rate that makes the net present value of the investment zero. ROR, on the other hand, simply calculates the total return on an investment without considering the timing or value of cash flows.
What is the difference between the hurdle rate and the discount rate, and how do they impact investment decisions?
The hurdle rate is the minimum rate of return required for an investment to be considered worthwhile, while the discount rate is used to calculate the present value of future cash flows. The hurdle rate influences whether an investment is accepted or rejected, while the discount rate affects the valuation of the investment. Both rates play a crucial role in determining the feasibility and profitability of investment decisions.
What is a good time weighted return and how can it be calculated effectively?
A good time-weighted return is a measure of investment performance that eliminates the impact of cash flows. It is calculated by taking the geometric mean of a series of sub-period returns. This method is effective because it accounts for the timing and size of cash flows, providing a more accurate measure of investment performance over time.
What is the difference between internal rate of return and interest rate, and how do they impact investment decisions?
The internal rate of return (IRR) is a measure of the profitability of an investment, taking into account the time value of money and the cash flows generated by the investment. It represents the rate at which the net present value of the investment becomes zero. On the other hand, the interest rate is the cost of borrowing money or the return on an investment, usually expressed as a percentage. The IRR is used to evaluate the potential return of an investment and helps investors compare different investment opportunities. It considers the timing and amount of cash flows, providing a more accurate picture of the investment's profitability. The interest rate, on the other hand, is the cost of borrowing money or the return on an investment, usually expressed as a percentage. In terms of impact on investment decisions, a higher IRR indicates a more profitable investment, while a higher interest rate may make borrowing more expensive and impact the overall cost of the investment. Investors typically look for investments with IRR higher than the cost of borrowing (interest rate) to ensure profitability.
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.
