Minimum required rate of return

Definition

The minimum required rate of return is the lowest acceptable return on an investment or project that a manager or investor is willing to accept. It serves as a benchmark for evaluating the viability and performance of investments or business segments.

5 Must Know Facts For Your Next Test

1. The minimum required rate of return is often aligned with the company's cost of capital.
2. It helps in decision-making by setting a threshold that projects must meet or exceed.
3. Projects with returns below this rate are typically rejected, as they do not add sufficient value.
4. It can vary between different companies and industries based on risk tolerance and financial strategy.
5. This rate is crucial for calculations involving Residual Income and Economic Value Added (EVA).

Review Questions

• Why is it important to establish a minimum required rate of return when evaluating investments?
• How does the minimum required rate of return relate to the cost of capital?
• What might happen if a project's return falls below the minimum required rate of return?

Related terms

Cost of Capital: The cost incurred by a company to finance its operations through debt, equity, or both.

Residual Income: The net income generated by an investment after subtracting the minimum required rate of return on operating assets.

Economic Value Added (EVA): A measure of a company's financial performance that shows the true economic profit after deducting the cost of capital from operating profits.