Note the distinction between your company’s required rate of return, which reflects its relative level of risk., and your company’s actual rate of return, which reflects its historical performance and is used to compute the company’s real ROI.
Your actual return may be above or below what you should be earning based on your investment’s risk.
THe required rate of return is the benchmark you must achieve to create value.
The required rate of return is also know as cost of capital, a required rate of return, or a dscount rate, and is sued to quantify the likelihood that future returns will be achieved.
Fundamental investment theory states that investors will accept higher risk in investment s only if they have an opportunity to earn a higher return.
Therefore, the higher the perceived risk in an investment, the higher the rate of return must be on that investment.
Thus, the greater the risk, the greater the discount rate, and the lower the value.
Conversely, lower risk would carry a lower discount rate and a higher value.
