What Does Required Rate of Return (RRR) Mean?
Required rate of return (RRR) is the minimum amount of money that an investor expects to receive from an investment. This amount takes into account several factors such as the amount of risk involved, inflation, liquidity and the duration of the investment. Based on these factors, investors determine what is the right amount of return that they would need in order to take on a certain amount of investment risk. In general, the minimum expected yield increases as risk increases and vice versa.
Divestopedia Explains Required Rate of Return (RRR)
The required rate of return can help a company's management team decide whether to pursue a particular growth project and to help investors decide which is the right investment for them at any given point in time. If an investor wants a safe investment and is willing to accept a lower return on the investment, then T-bills or CDs are a good investment choice. On the other hand, if an investor wants a higher percentage of return and is willing to take more risks, then equities and other similar investments are a good choice.
Sometimes, the cost of capital of an individual or an institution determines the minimum acceptable rate of return for them. For example, if an investor borrows money at the rate of 10% per year, then the required rate of return should be at least 11% per year, so that the cost of capital is covered and the investor also gets to make some profit.
Other aspects, such as liquidity, also have a bearing on the required rate of return. In general, investments with higher liquidity have a lower rate of return because it gives investors the option to convert their investments into cash within a short period of time. So, the required rate of return determines what investment should be made by an investor. While some investors prefer higher returns, others may opt for lower risk.