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The cash-on-cash return is a strategy for determining the rate of return on a given investment. Generally, the calculation for a cash-on-cash return is employed when there is no secondary market involved with the investment. This approach can be a great way to project the rate of return on a monthly or quarterly basis, or to figure the annual dollar income that could be generated for the total dollar investment.
In order to understand how the cash-on-cash return works, it is helpful to understand what a secondary market is and why this type of calculation will not work in that environment. A secondary market is a situation in which the investor purchases a security directly from another investor, rather than purchasing the security from the issuer. This added dimension to the transaction can add a layer of risk that cannot be easily accounted for in the usual process for determining the cash-on-cash return, due to the presence of a third party in the financial transaction.
Calculating the actual return on investment with the cash-on-cash return approach is very simple. Essentially, the cash-on-cash return will divide the annual dollar income by the total dollar investment. The result will be a percentage amount that will reflect the annual return achieved for the initial investment in the asset. This can also be drilled down to quarterly and monthly percentages with a little more calculation, if the investor wishes to track the amount of return that is realized in shorter time frames.
Ideally, the determination of the cash-on-cash return will result in a relatively high percentage of annual return. When this is the case, chances are the investor will choose to hold on to the investment for an extended period of time. At the same time, an investment that tends to generate a lower cash-on-cash return for two periods may indicate that the investor would do well to sell the asset and invest in another opportunity.