Return, calculation

The rate of return is often calculated for the anticipated best year of the project the year in which the net cash flow is greatest. It can also be based on the book value of the investment, the investment after allowing for depreciation. Simple rate of return calculations take no account of the time value of money. 

Both methods assume that the money earned can be reinvested at the nominal interest rate. Suppose the rates of return calculated are after tax returns and the company is generally earning a 5% or 6% return on investment. Is it reasonable to expect that all profits can be reinvested at 23% or even 20% No, it isn t Yet this is what is assumed in the Rate of Return method. Sometimes the rate of return may be as high as 50%, while a reasonable interest rate is less than 15%. Therefore if a reasonable value for the interest rate has been chosen (this is discussed later in this chapter) and the two methods differ, the results indicated by the Net Present Value method should be accepted. 

Neglect interest during construction period and value-of-land effects. Note Rate of return calculations for your company must be based on discounted-cash-flow procedures to account for the time value of money. 

DISCOUNT CASH FLOW RATE OF RETURN CALCULATION... 

FORMAT (///,20X, DISCOUNT CASH FLOW RATE OF RETURN CALCULATION, /IH, 78(1H ))... 

Yield to call This method calculates the yield for the next available call date. The yield to call is determined assuming the coupon payment until the call date and the principal repayment at the call date. For instance, the yield to first call is the rate of return calculated assuming cash flow payments until first call date. When interest rates are less than the ones at issue, the yield to call is useful because most probably the bond will be called at next call date ... 

For index-linked gilts, institutional investors that are taxed are treated in the following way. An inflation tax relief is granted based on the inflation experienced between tax year-ends. This relief is deducted from the total return (calculated on a mark-to-market basis or an accrual basis, according to the an election made by the investor), and the difference is taxed. This means that index-linked enjoy a material tax advantage over nominal gilts—the intent and effect is that investors are only taxed on their real return, not on inflation compensation. 

Period over which expenses incurred Estimated amount Period over which returns calculated Estimated Amount ... 

The return calculated using (14.21) is based on several assumptions. The best way to obtain an idea of the return likely to be generated over the holding period is to compute a range of returns by using a range of values for each assumption. 

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