Required rate of return , Financial Management

Required Rate of Return (Ri

The required rate of return (Ri) is the minimum rate of return that a project must generate if it has to receive funds.  It’s thus the opportunity cost of capital or returns predictable from the second best option. In common,

Required Rate of Return = Risk-free rate + Risk premium

Risk free rate is compensation for time and is made up of the real rate of return (Rr) and the inflation premium (IRp). The risk premium is reimbursement for risk of financial actions exhibiting:

-    The riskiness of securities caused by term to maturity
-    The security liquidity and marketability
-    The consequence of exchange rate fluctuations on the security, and so on.

The requisite rate of return can hence be expressed as follows:

Rj = Rr +IRp +DRp +MRp + LRp + ERp + SRp + ORp.

Where:

1) Rr is the actual rate of return which compensates investors for giving up the utilization of their finances in inflation free and risk free market.

2) IRp is the Inflation Risk Premium that compensates the investor for the reduction in purchasing power of capital caused by inflation.

3) DRp is the Default Risk Premium that compensates the investor for the possibility that users of finances would be unable to pay back the debts.

4) MRp is the Maturity Risk Premium that compensates for the term to maturity.

5) LRp is the Liquidity Risk Premium that compensates the investor for the option that the securities given are not simply marketable (or convertible to cash).
6) ERp is the Exchange Risk Premium that compensates the investors for the fluctuation in exchange rate. This is mostly significant when the funds are denominated in foreign currencies.

7) SRp is the Sovereign Risk Premium that compensates the investors for the option of political instability in the country in which the funds have been given.

8) ORp is the Other Risk Premium example, the kind of product, the type of market, and so on.

Posted Date: 12/8/2012 6:13:34 AM | Location : United States







Related Discussions:- Required rate of return , Assignment Help, Ask Question on Required rate of return , Get Answer, Expert's Help, Required rate of return Discussions

Write discussion on Required rate of return
Your posts are moderated
Related Questions
Q. Explain about Current Value? Current Value - (1) Value of an ASSET at present time as compared with asset's HISTORICAL COST. (2) In finance, amount determined by discounting

How does a sinking fund function in the retirement of an outstanding bond issue? Where a company puts payments that are then used to buy back outstanding bonds is known as a si

The production department in any firm is concerned with provision of production facilities, production cycle, skilled and unskilled labor, storage of finished goods, capacity utili

ABC Ltd. Produces electronic components with a selling price per of Rs.100. Fixed cost amount to Rs.2,00,000/- 5000 units are produced and sold each year. Annual profits amount to

The modified duration is a measure of the sensitivity of a bond's price to interest rate changes; the assumption made here is that the expected cash flow does not

Stock A has settled into a constant dividend growth pattern of 6 percent per year. The current dividend is $1.50, its current price is $15.90. You are an analyst and believe that

Explain the Benefits of benchmarking - Better understanding of business, competition and customers. - Improves business performance and discourages complacency. - Good wa

Question 1: Analyze the practice of democracy as advocated by the early Greek political thinkers. Question 2: To what extent can Man live peacefully with each other wi


Q. Advantages of Just-in-time inventory management? JIT inventory management methods look for eliminate waste at all stages of the manufacturing process by minimising or elimin