Week 8 Discussion What is the true rate of return (3189368)

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Running Head: WEEK 8 DISCUSION; TRUE RATE OF RETURN Week 8 Discussion: What is the true rate of return? Student’s Name Institution Affiliations Course Details Instructor Due Date

2 WEEK 8 DISCUSION; TRUE RATE OF RETURN How should investment returns be measured? Do financial services companies have an incentive to provide nominal rather than true rates of return in their advertising? Should they be required to provide nominal, real, and true rates of return? In most cases investors, and business managers experience problems when expressing return on investment. In some cases, taxes are not included and when they are, inflation rate is excluded. In other cases, both tax and inflation are not avoided. For any investment within a business entity, a real asset which could be a piece of diagnostic equipment in the ambulatory surgery center its appropriate to assign its appropriate value to the cash flows that arise at the dissimilar points in time through time value evaluation. Time value analysis is important an significant health care financial management tool as most of the financial venture analysis are valuated in respect to future cash flows ( Sultz & Young, 2021) . There are two methods in time value analysis that are used to quantity the rate of return on investment, that is, in terms of dollars and in percentage terms. Dollar return represents the present value if the cash flows of an asset or an investment ( Sultz & Young, 2021) . To quantity the dollar return on an asset or an investment, the financial value of that asset or investment must be compared with the present value of the expected benefits or the expected cash inflows. For example, if an equipment will cost a radiology department $ 250,000 with an opportunity cost of 10%, and the present value is $ 310,675, then the expected dollar return on that equipment is $ 60,675. The dollar return is subject to time value and the opportunity costs in the discounting procedure. The $ 60,675 excess return is the is usually referred as the NPV. It is clear that the NPV is larger than the 10% rate of the opportunity cost. It can be seen that the investment is of value as it produces an extra dollar return to the organization.

3 WEEK 8 DISCUSION; TRUE RATE OF RETURN The rate of return or percentage return is the measure of return on investment that evaluates the interest rate in which an asset spending to generate the expected cash inflows. Basically, it is the measure of that provides the expected periodic rate of return on investment or an asset. In the case that the cash inflows are expressed annually, then the rate of return is an annual rate ( Sultz & Young, 2021) . This means that we are calculating the interest rate that associates the sum of the present values of cash inflows to the dollar amount of the cash expense. In an instance that the present value of the cash inflows equal to the investment outlay over a specified period of time, then the net present value (NPV) is forced to zero dollars. The rate of return is a measurement of an investment or an asset’s performance but a nominal rate of return is an evaluation of the growth rate of an investment before accounting for inflation, taxes and before investment expenses factors in. Other sources refer the nominal rate of return as a gross rate of return. The real rate of return accounts for an annual realized growth computed after deducting taxes and inflation. Real rate of return is an important expression as it expresses an investment’s annual growth rate in a real case. Let’s consider a case in which an investment of $ 10,000 a dollar return of $1,000 within a financial year. This means that the business was able to generate 10% return from its investment of $ 10,000 which really sounds so good. As of December 2021, the rate of inflation was 4.7% (Statista, 2022). As the purchasing power is eroded by inflation, the cash of the investment would have to earn 4.7 100 ×$ 10,000 = $ 470 even by just holding the money. In that case, the real dollar return would be $ 1,000 − $ 470 = $ 530 . This would in turn degrade the annual rate of return of the investment to 10% − 4.7% = 5.3% . Secondly, let’s consider the taxes rate on income is 30%, this means

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4 WEEK 8 DISCUSION; TRUE RATE OF RETURN that 30 100 ×$ 10,000 = $ 300 will be paid to the government as tax. The dollar return will reduce to $ 530 − $ 300 = $ 230. $ 230 is the annual usable or annual true dollar return on investment to the business entity. From the annual true dollar return an annual true rate of return can be computed $ 230 $ 10,000 × 100 = 2.3% . To an investor, the value is really annoying and disappointing when compared to the nominal rate of return which was 10%. In summary 10% − 2.3% = 7.7% of return withered away after the inflation and corporate tax on income were incorporated. In most cases, the nominal rate of return appears to be comforting to investors and they are likely to use it instead of the real rate of return which is seen to be very disappointing. However, the nominal rate of return does not unveil how much usable income is generated by the investment. An investment must appreciate the generated usable income as nominal rate of return is just an illusion and not a true representation of what the business really gained on the investment. In my view, financial services firms have an incentive to state the true rates of return and not the nominal rates during advertisements. I think its unethical to tell an potential investor that your business generated 10% return on investment without clearly specifying that it’s the nominal rate and not the true value while the true rate of return is only 2.3%. However there exists a limitation of stating the true rate of return due to other factors that make the computation inaccurate. The inflation rate for example may be miscalculated, the inflation rates are mere approximates as they are calculated based on trailing. Basically, the indicated rate of inflation does to accurately reflect the true rate of inflation as rounding errors in the calculation of the consumer price index introduces additional source of statistical errors ( Williams, 2016) . Use of rounded CPI data sets reveals that the published values differ from the unrounded benchmark up to 25% in most cases

5 WEEK 8 DISCUSION; TRUE RATE OF RETURN and errors can be large relative to the underlying inflation rate ( Williams, 2016) . The values would only be accurate if the real-data of the reported CPI had the highest precision reducing the rounding errors in inflation rates calculations. The given inflation rate is merely an educated guess. In conclusion, I feal that the advertising company should clearly label the true, real and nominal return rates and in the case they do not, the investor has the right to know these values. In the case that an investment is long-term, these values should be clearly indicated. In a short-term project, nominal values may be used but the expected inflation and taxes rates must be footnoted ( Williams, 2016) .

6 WEEK 8 DISCUSION; TRUE RATE OF RETURN References Statista. (2022, February 16). United States - monthly inflation rate in January 2022 . Retrieved March 1, 2022, from https://www.statista.com/statistics/273418/unadjusted-monthly- inflation-rate-in-the-us/#:%7E:text=The%20annual%20inflation%20rate%20in,available %20funds%20to%20make%20purchases . Sultz, H. A., & Young, K. M. (2021). Hospitals: origin, organization, and performance. HealthCare USA, understanding its organization and delivery. Mississauga, ON: Jones; Bartlett Learning, 69-119. Williams, E. (2016). The effects of rounding on the Consumer Price Index. Monthly Lab. Rev. , 129 , 80.

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