Rate of return (RoR) is the net gain or loss on an investment through a certain period. The Rate of Return is indicated as a percentage of the invesment’s initial value. The Rate of Return Formula Rate of Return=[((Current Value - Initial Cost))/(Initial Cost)]×100 The particular Rate of Return is also named as Basic Growth Rate, or Return on Investment - (ROI) depending on where it is used. If the time value of money and the effect of inflation is also taken into consideration; the rate of return which reflects more realistic results is defined as the Discounted Cash Flows which stands for the net amount received after an investment / initial cost. Applications of Rate of Return A rate of return can be applied to any investment medium, varying from stocks, to machinery, fine art, and real estate. In each of these alternatives of Rate of Return; an investment is made in an asset to produce cash flow later in the future. Investments are compared against assets of the same type to reveal which investments are more feasible. Additionally; The rate of return is used to determine benefit between two different time periods, rather than several periods. The calculation of the Rate of Return does not include the effects of inflation. An Example of Rate of Return As illustrated in the formula above; it is assumed that $1,500 is invested in a company's stock two years ago(T - 2), and now(T) the value of stock is $3,200. The intial value is subtracted from the current value, which makes $1700. Then, the particular amount is divided by the absolute cost of $1,500 (the value which was invested initially. At last, the answer is multiplied by 100%. Illustrating this example; 1. Subtract current balance from original investment: $3,200 - $1,500 = $1,700 2. Divide difference by the absolute value of original investment: $1,700 / $1,500 = 1,133 3. Multiply the quotient by 100% to turn it into a percentage: Rate of Return: 1,133 x 100% = 113,3% An Example Table of Calculating RoI The Difference of RoR on Stocks and Bonds Calculation of the rate of return for bonds and stocks are not the same. It is assumed that a certain investor buys a stock for $60 per share, and the stock is owned for five years, and total amount of $10 is earned in dividends. The stocks are sold for $80, this makes a per share gain of $80 - $60 = $20. Additionally, $10 in dividend income is also earned making a total gain of $20 + $10 = $30. Therefore the gain per share comes up to be $30, dividing it by the initial cost of $60 cost per share makes 50% - ($30 / $60 = 0.50) However, considering a certain investor paying $1,000 for a $1,000 par value 5% coupon bond. $50 is earned by the investment by interest income per year. Assuming the investor to sell the bond by $1,100 premium value and earning a total interest of $100; the Rate of Return of the particular investment is the $100 gain by the sale. Additionally, $100 interest income divided by the $1,000 investment value, or 20%. Difference Between Real and Nominal Rates of Return Nominal Rate of Return is not affected by the inflation by time. However, the effect on inflation decreases the purchasing power of money. This means; $100,000 five years from now on is not equal to the $100,000 today. This is called the Real Rate of Return or Inflation-Adjusted Rate of Return. Compound Annual Growth Rate Compound Annual Growth rate is a concept similar to simple Rate of Return. Is it abbreviated as CAGR. The mean of rate of return in annual terms of an investment which is over a specified time longer than a single year. In other words, the calculation should factor through multiple periods of time in growth. In order to calculate CAGR, the cost of a certain investment is divided at the end of the period by its beginning value of the time period. The result value is raised to the power of one which is divided by the number of awaiting periods, and subtracted one from the following result value. Internal Rate of Return and Discounting Cash Flows Compound Annual Growth Rate ignores the Time Value of Money. Discounted cash flows include the profits of an investment and discount each of the cash flows depending on a discount rate. A minimum rate of return acceptable to the investor is represented by the Discount Rate, in other words an assumed rate of inflation. Rather than only investors, enterprises also use discounted cash flows to reveal the feasibility & profitability of their investments. The Rate of Return considering discounted cash flows is known as Internal Rate of Return, or IRR, as well. It is a discount rate making the net present value of all cash flows from a certain investment equal to zero.