Question

What is the required rate of return ? Please also elaborate on the following

- Can the required rate of return be used as the cost of equity in a cost of capital calculation ?

- can the rate of return and the cost of equity be used to determine one another , if so , how?

- is there a difference between the "rate of return" and the "required rate of return" ?

Answer 1

1.

Required rate of return is the rate of return that makes present value of cash flows equal to the present value of cash outflows. At required rate of return, B/C ratio, will be 1.

2.

Yes, cost of equity is the return expected by the investor upon its investments. If it  makes the present value of cash inflows equal  to the initial investments, then cost of equity will be used as the required rate of return.

3.

In general, rate of return and cost of equity are treated as same. Though, the rate of return is the return offered by the investors, but cost of equity is used as a minimum return expected on investment. Cost of equity can be used to determine rate of return, because cost of equity is derived by the opportunity cost or other best return achieved from the market. This minimum return will identify the cost of equity and it will become the benchmark for the rate of return and it should be atleast equal to cost of equity.

4.

Rate of return is the expected return from the investment, but required rate of return makes present value of cash flows equal to the present value of cash outflows. So, for any investment plan, required rate of return is fixed, but rate of return can vary. If rate of return is bigger than the required rate of return, then project is accepted.