What is the Time-Adjusted Rate of Return?

The time-adjusted rate of return is the discount rate that causes the present value of cash inflows associated with an investment to equal the present value of its cash outflows (usually the initial cash outlay and any incremental increase in working capital). The measure incorporates the time value of money, and so is superior to the accounting rate of return, which does not do so.

When to Use the Time-Adjusted Rate of Return

Here are several scenarios in which using the time-adjusted rate of return makes sense:

Capital budgeting for long-term projects. When a company is considering significant capital investments—such as building a new facility, purchasing machinery, or launching a large-scale infrastructure project—the time-adjusted rate of return helps determine if the expected returns justify the upfront costs by accounting for the timing of cash inflows and outflows.
Real estate investments. Real estate projects often involve substantial initial investments and periodic cash inflows from rent or property sales. Using the time-adjusted rate of return allows investors to assess the profitability of these projects by factoring in the timing of rental income and the sale proceeds relative to the initial outlay.
Private equity and venture capital. Venture capital investments typically involve staggered cash inflows from eventual exits or IPOs. The time-adjusted rate of return helps investors evaluate potential returns by comparing the timing of expected cash flows against the initial and subsequent funding rounds.
Evaluating mergers and acquisitions. In M&A scenarios, acquirers use the time-adjusted rate of return to assess the value of future cash flows from the acquired company relative to the purchase price. It helps in determining if the acquisition would generate adequate returns over time.
Renewable energy projects. Investments in renewable energy, like solar or wind farms, require substantial upfront costs with cash inflows generated gradually through power sales. The time-adjusted rate of return is valuable for assessing if the future cash inflows adequately compensate for the initial investment and the timing of returns.

How to Calculate the Time-Adjusted Rate of Return

The time-adjusted rate of return is most easily calculated by using the internal rate of return (IRR) formula in an Excel spreadsheet. Though the calculation is invisible to the user, the formula essentially brackets the likely rate of return, and then uses multiple iterations to back into the exact amount. The metric is significantly more difficult to calculate when future cash flows are uncertain, and especially when they are expected to vary from period to period.

While the time-adjusted rate of return is a reasonable method for arriving at a quantitative view of a proposed investment, it should be supplemented with other information, such as how the investment is used to increase the capacity of a bottleneck operation, how it can reduce working capital, and/or how it resolves a legal requirement imposed by a local government.