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What is return required by investors?
The required rate of return is the minimum return that an investor accepts for a particular investment. It is a way to compensate the shareholders for the risk they are taking by investing in a particular company. Also, known as the hurdle rate of return, the investors will most likely refrain from investing if they feel if the expected return of investment fails to meet the return required by investors.
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What is the process of calculation?
The required rate of return is calculated through the Capital Asset Pricing Model. However, in order to do so, the other variable in the CAPM model has to be found out. These include:
Required rate of return= risk free rate+ beta (return of the market-risk free rate)
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Factors that influence required rate of return
There are three major factors which influence the required rate of return. The understanding of these factors is crucial to ensure progress in finance. Listed below are the three factors:
For higher risks, the required rate of return is higher whereas for lower risks, it is correspondingly low.
A high inflation rate will result in an increase in required rate of return.
If an investment cannot be liquidated for a number of years, it increases the risks. As a result, it increases the required rate of return.
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