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 factor in the time value of money.
The measure is commonly used to develop rate of return information for one or more proposed expenditures for fixed assets. Management may use the measure as one of several deciding factors to select one proposed expenditure over another. Other factors that may impact the decision include the impact on the company bottleneck operation, quality issues, and risk mitigation concerns. Alternatively, any proposed project may be approved, as long as its time-adjusted rate of return exceeds the corporate cost of capital.
The metric 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.
The time-adjusted rate of return is also known as the internal rate of return.