What Is Normal Rate of Return?

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  • Written By: Esther Ejim
  • Edited By: Kaci Lane Hindman
  • Last Modified Date: 19 May 2020
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The normal rate of return is used to describe the rate of loses or gains from an investment. That is to say that it is the calculation of the profits made from an investment after subtracting the capital, investment and operating costs. It is a benchmark that investors use to decide if a business is a worthy investment, or if they should look elsewhere. Businesses also use it to calculate if the business is making any reasonable profits and by what percentage.

This assessment may be used by someone trying to start a new business. The information may be obtained by studying the posted profits of a spectrum for a similar business in the industry, taking into consideration factors like the environment and other issues that may affect that particular business in its proposed location. For instance, a potential watch manufacturing entrepreneur may study the rate of loses or gains for that industry with regards to aspects like government regulations, taxes, import duties and other factors that may affect business profitability. The profit of a business is usually affected by such considerations even if the sales and prices of the products are similar in different markets.

Two companies might make the same product, sell the same quantity per month at the same price, and yet the normal rate of return might be different. This may be due to the locations of the businesses. One of the businesses could be located in an environment where the government grants certain tax concessions and reduces custom duties for some necessary raw materials. Another factor that may affect the rate is if the company is able to hire a cheap work force. The operating cost will be cheaper than another similar company where the environment is not so favorable and leading to higher profits.

In various industries, normal rate of return is also affected and determined by the various unique markets. For instance, an apparel manufacturing industry will have a different rate from a car manufacturing industry. One of the factors that affect how a market might be described as profitable is the risk factor associated with the industry. Industries with higher risk factors typical require a high margin of return before they can be declared profitable, unlike lower-risk markets that may be deemed successful with only a fraction of the same profit.

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Would the normal rate of return change over time?

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