The required rate of return (RRR) is the minimum return an investor will accept for owning a company's stock, as compensation for a given level of risk associated with holding the stock. The RRR is also used in corporate finance to analyze the profitability of potential investment projects. Key Takeaways
Full Answer
What is a'required rate of return'(RRR)?
What is a 'Required Rate Of Return - RRR'. The required rate of return, also known as the hurdle rate, is the minimum return an investor will accept for an investment or project, that compensates them for a given level of risk.
How do you calculate RRR in CAPM?
To calculate RRR using the CAPM: 1 Subtract the risk-free rate of return from the market rate of return. 2 Multiply the above figure by the beta of the security. 3 Add this result to the risk-free rate to determine the required rate of return. More ...
How do you calculate required rate of return on stocks?
Required Rate of Return Formula. Required rate of return = risk-free rate + beta of the security (expected market return – risk free rate) The RRR on a stock is the minimum rate of return on a stock that an investor considers acceptable, taking into account their cost of capital, inflation and the return available on other investments.
How do you calculate return on investment (RRR)?
Another way to calculate RRR is to use the capital asset pricing model (CAPM), which is typically used by investors for stocks that don't pay dividends. The CAPM model of calculating RRR uses the beta of an asset.
What is required rate of return?
The required rate of return (RRR) is the minimum return an investor will accept for owning a company's stock, as compensation for a given level of risk associated with holding the stock. The RRR is also used in corporate finance to analyze the profitability of potential investment projects.
How to calculate RRR?
To calculate RRR using the CAPM: 1 Subtract the risk-free rate of return from the market rate of return. 2 Multiply the above figure by the beta of the security. 3 Add this result to the risk-free rate to determine the required rate of return.
What is RRR in retirement?
The RRR is a subjective minimum rate of return; this means that a retiree will have a lower risk tolerance and therefore accept a smaller return than an investor who recently graduated college and may have a higher appetite for risk. The RRR is also known as the hurdle rate, which like RRR, denotes the appropriate compensation needed for ...
What is the RRR?
The RRR is also known as the hurdle rate, which like RRR, denotes the appropriate compensation needed for the level of risk present. Riskier projects usually have higher hurdle rates, or RRRs, than those that are less risky. 1:29.
Does RRR factor in liquidity?
RRR does not factor in the liquidity of an investment. If an investment can't be sold for a period of time, the security will likely carry a higher risk than one that's more liquid. Also, comparing stocks in different industries can be difficult since the risk or beta will be different.
Does RRR factor inflation?
Limitations of Required Rate of Return (RRR) The RRR calculation does not factor in inflation expectations since rising prices erode investment gains. However, inflation expectations are subjective and can be wrong. Also, the RRR will vary between investors with different risk tolerance levels.
Is RRR the same as cost of capital?
Although the required rate of return is used in capital budgeting projects, RRR is not the same level of return that's needed to cover the cost of capital. The cost of capital is the minimum return needed to cover the cost of debt and equity issuance to raise funds for the project. The cost of capital is the lowest return needed to account for the capital structure. The RRR should always be higher than the cost of capital.
Required Rate of Return in Investing
The required rate is commonly used as a threshold that separates feasible and unfeasible investment opportunities. The general rule is that if an investment’s return is less than the required rate, the investment should be rejected.
How to Calculate the Required Rate of Return?
There are different methods of calculating a required rate of return based on the application of the metric.
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