In simple words, The rate of return is the gain experienced over a period of time expressed in terms of the initial investment.
Calculating Rate of Return
To understand the concept more deeply let me show you an example.
Let’s say your company is considering buying an investment product sold by JPMorgan that requires an outlay of $100,000 today and generates a payoff of $120,000 next year.
In this example, the rate of return is calculated by dividing the Gain and initial investment.
Gain = $120,000 – $100,000
Initial Investment = $100,000
That is, the rate of return is 20%.
We say that this is an annual rate of return since the payout is one year after the investment is made.