Q:

How do you calculate the rate of return?

A:

Quick Answer

Use the capital asset pricing model to calculate the required rate of return for a stock, as Investopedia explains. Estimate a risk-free rate, determine the stock's market return, and research the stock's beta or calculate it manually. Input these numbers into the model's equation to get the rate of return.

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Full Answer

The yield-to-maturity rate of a 10-year treasury bill provides a good estimate of the risk-free rate, according to Investopedia. A brokerage may supply an estimate of the stock's overall market return, or you can calculate it based on the stock's historical yearly market returns. Most investment websites list a stock's beta, but you can also calculate it using a regression model equation. Another method for calculating rate of return is the dividend discount model, which uses the current stock price, the dividend payment and an estimate of the growth rate for dividends in its equation.

The required rate of return sets an appropriate minimum return on an investment after factoring in risk, cost, volatility of the stock and other factors, according to Investopedia. Corporations and professionals involved in equity valuation use the required rate of return to calculate the present value of dividend income, free cash flow to equity and operating free cash flow. These factors help them make decisions about expansion, debts, equities, marketing and project funding.

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