Average Rate of Return (on an Investment) – the average profit each year as a percentage of the original investment

To remember what Average Rate of Return (on an Investment) means use the following mnemonic:

On average the investor got a great amount of money returned (average rate of return) to him each year. The profit each year from the original investment was substantial. 

Some businesses will only invest in a project if they can make a 10% return on their investment. If a business person puts their money in an interest only account, they may get 2% interest per year, OR they could put it in stocks and shares and hope to get at least 5% return on investment each year. However, by investing in a business directly, they could get over 10% return per year on their investment.

To work out the average rate of return on an investment use the following formula:

Average\ rate\ of\ return\ on\ an\ investment\ =\ \frac{Annual\ profit}{Cost\ of\ the\ investment}\ \times\ 100

The higher the value the greater the return on the investment.

Here is an example:

A machine costs £2,000,000 and is expected to increase profits by £300,000/year the average rate of return on the investment is:

Average\ rate\ of\ return\ on\ the\ investment\ =\ \frac{300,000}{2,000,000}\ \times\ 100\

                                                                             = 0.15 x 100

                                                                             = 15%

The average rate of return of this investment is 15% per year which is a superb return on your money.