Average rate of return

Average rate of return

Continuing with the example from Simple Investment Stream, the average annual return of the projected scenario is simply the net return over the 20 year operating period divided by the number of years:

  • 49 104 311 DKK / 20 years = 2 455 216 DKK/year

To find the average rate of return, this sum is then divided by the initial investment:

  • 2 455 216 DKK / 24 459 750 DKK = 0.1004

That is, the average annual rate of return is 10.04 percent.

For the revised scenario the annual rate of return is:

  • 51 625 811 DKK / 20 years = 2 581 291 DKK/year

To calculate the average rate of return:

  • 2 581 291 DKK / 24 459 750 DKK = 0.1055

Equal to 10.55 percent.

The main issue with this method of calculation (besides ignoring the value of time preference) is similar to the one arising from the internal rate of return. Since all the values are simply summed, it makes no difference to the result whether all the returns from the investment are distributed evenly over the period (as is true for this example) or only occur in the last two years of the operating period - but to an investor a return received annually might be preferred to receiving a larger one only after 18 years of waiting.

Created by system. Last Modification: Friday 21 May 2010 15:04:39 CEST by tanja.groth.