Return on Investment can be defined as; the interest rate where present worth of
ID: 1223868 • Letter: R
Question
Return on Investment can be defined as;
the interest rate where present worth of a project = 0,
The interest the bank charges on a loan,
The inverse of the payback period.
The inverse of the payback period & the interest rate where present worth of a project = 0,
A.the interest rate where present worth of a project = 0,
B.The interest the bank charges on a loan,
C.The inverse of the payback period.
D.The inverse of the payback period & the interest rate where present worth of a project = 0,
Explanation / Answer
Investment is made in capital project. Its expected net cash flow of the life time is ascertained. Then you have to consider the minimum required rate of retur. Convert future cash flows into equivalent present value using miimum required rate for discounting. Add the annual present value of the future cash flows. You will get gross present worth. Deduct initial investment from it to get net present worth. If it is positive, then you can say that return from investment is more than minimum required rate. But it will not indicate return from investment.
For estimating return from investment, you have to increase the discounting rate gradually above the minimum required rate. You will get a rate which will make net worth equal to zero. This rate is known as interal rate of return. It is the required rate of return from investment.
Pay back period cannot indicate rate of return. It is the time required to recover initial investment. No return after pay back period is considered here. So it cannot indicate rate of return. If you take inverse of pay back, then it will indicate return for recovering iniitial investment.
So correct answer is option A. Return of investment is the interest rate where present worth of a project=0.
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