(1) Cost of capital is the investor's required rate of return, it's a very important concept in the modern financial theory.

(2) Typically the required rate of return is based on projects of equivalent risk.

(3) Some attention should be given to choosing the required rate of return to make sure that it adequately accounts for the risk of the project.

(4) For example, using the same logic and assuming a constant required rate of return, may be defined as follows:.

(5) As this model stands it is rather cumbersome even with the simplifying assumption of a constant required rate of return.

(6) The second is to determine the value of an investment by dividing the annual return by the investor's required rate of return.

(7) where the "end of the project" is really the lifespan of the solution and r is the discount rate, or required rate of return, of the project.

(8) Alternatively, variability in the estimates can be accommodated by increasing the required rate of return for the project in the NPV calculation.

(9) Both projects have the same life, require the same initial outlay, have positive NPVs and have IRRs greater than the required rate of return.

(10) Thus, if the NPV is greater than zero, then the IRR is also greater than the required rate of return.

(11) This internal rate of return (IRR) for the project is then compared to a minimum required rate of return for projects of similar risk.

(12) Obviously, the IRR is between 6% and 7%. Because the IRR is far in excess of the required rate of return(), an accurate calculation is unnecessary.

(13) Term used in investment analysis or capital budgeting that means the required rate of return in a discounted cash flow analysis.