Required rate of return is the rate of return that an organization should achieve such that it compensates the time value of money, the expected rate of inflation and the risk involved. The concept is that each unit of money you invest has a time value. This means the value of the same unit of money is higher in the present time than compared to the future time. Thus one unit of money today has higher purchasing power yesterday and the one unit of money in the future has more purchasing power today. There are formulas to calculate the time value of money. It can be found from any books in future.
Additionally the expected rate of inflation should also be adjusted so that we can manage our earnings. If the expected inflation rate is not adjusted, then the company may lose income or they may run at a loss. This is because the price of goods and commodities increases over time and it's very unlikely that it decreases. Thus if it is expected to earn $100,000 which can be spent to purchase machinery, inflation may mcause the price of machinery to be $150,000. Thus the operation of the company can be affected. For this reason the expected inflation rate of $50,000 should be adjusted to the machinery product and the required rate of return should be calculated.
Further the required rate of return should adjust the risk involved. This means if man organization is undergoing a risky project which can give them a huge loss then they must only accept the project if it gives them huge profit also. On the opposite hand, if an organization is planning to take a project on hand which gives them minimal loss, then they can also accept to take minimal profit. This simply means that the required rate of return should be decided on the basis of the risks amount the company is willing to take while choosing a project.
Thus,
Required rate of return= The time value of money+ Expected rate of inflation + Risk Involved.
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