This rate of return calculator estimates the profitability of a business or investment measured by its discount rate which is also known as compound annual growth rate. There is in depth information on how to determine this financial indicator below the tool.
How does this rate of return calculator work?
The rate of return is an important financial figure each investor is looking at before deciding to invest or not in a new or existing opportunity. This application requires the value of the initial investment or the so called starting principal (present value – PV), the total return of the investment at the end of the period (future value – FV) and the term of the investment in years.
The algorithm behind this rate of return calculator uses the compound annual growth rate formula, as it is explained below in 3 steps:
- First divide the Future Value (FV) by the Present Value (PV) in order to get a value denoted by “X”.
- Then raise the “X” figure obtained above by (1/ Investment’s term in years. More specific: X^(1/Investment’s term) – where ^ is the sign for power. After this calculation a new value will be obtained which is denoted with “Y”.
- Finally subtract 1 from “Y” and then multiply the resulting figure by 100 to obtain the rate of return in percentage format.
How to calculate return rate
Let’s us assume the following example:
-Present Value (PV) = $20000
-Future Value (FV) = $80000
-Investment’s term = 10 years.
Step 1: 80000/20000=4
Step 2: 4^(1/10)=4^0.1= 1.148698355
Step 3: (1.148698355-1)*100=14.87%.
Understanding the usability of the rate of return
Usually investors compare the rate of return of an investment with the annual inflation rate or with the effective interest rate bank offers on deposits in order to check whether the investment’s return covers or not the inflation within the time frame given.
Since this figure indicates how profitable can a business be, the higher the rate of return the better for the investor is. Please keep in mind that usually high levels of ROI are associated with a high risk profile of the investment in question.
Typically the higher the risk is the higher the rate of return, and so when assessing an opportunity it is important that the investor analyses both the associated risk and its likelihood and its rate of return level.07 Mar, 2015 | 0 comments