Required Rate Of Return - RRR


DEFINITION of 'Required Rate Of Return - RRR'

The minimum annual percentage earned by an investment that will induce individuals or companies to put money into a particular security or project. The required rate of return (RRR) is used in both equity valuation and in corporate finance.
Investors use the RRR to decide where to put their money. They compare the return of an investment to all other available options, taking the risk-free rate of return, inflation and liquidity into consideration in their calculation. For investors using the dividend discount model to pick stocks, the RRR affects the maximum price they are willing to pay for a stock. The RRR is also used in calculations of net present value in discounted cash flow analysis.

Corporations use the RRR to decide if they should pursue a new project or business expansion; in corporate finance, the RRR is equal to the weighted average cost of capital (WACC).


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BREAKING DOWN 'Required Rate Of Return - RRR'

You might require a return of 9% per year to consider a stock investment worthwhile, assuming that you can easily sell the stock and inflation is 3% per year. Your reasoning is that if you don't receive a 9% return, which is really a 6% return after inflation, then you'd be better off putting your money in a CD that earns a risk-free 3% per year (really 0% after inflation). You aren't willing to take on the additional risk of investing in stocks, which can be volatile and whose returns are not guaranteed, unless you can earn a 6% premium over the risk-free CD. The RRR will be different for every individual and every company depending on their risk tolerance, investment goals and other unique factors.

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  1. What are the drawbacks of using the Dividend Discount Model (DDM) to value a stock?

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  2. How do I find the information needed for input into the Dividend Discount Model (DDM)?

    Analysts and investors should utilize a company’s financial statements, stock information websites and any number of analysis ... Read Full Answer >>
  3. What does the Dividend Discount Model (DDM) show an investor about a company?

    The dividend discount model, or DDM, is not designed to be used in forecasting any possible capital gains from increases ... Read Full Answer >>
  4. How do you calculate costs of capital when budgeting new projects?

    A new project only makes economic sense if its discounted net present value (NPV) exceeds the expected costs of financing. ... Read Full Answer >>
  5. What is the difference between the cost of capital and required return?

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  6. How do treasury bill prices affect other investments?

    The prices for Treasury bills (T-bills) can have a significant impact on the risk premium charged by investors across the ... Read Full Answer >>
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