1. What is the External Rate of Return (ERR)?

The External Rate of Return (ERR) is a financial metric used to evaluate the profitability of an investment by comparing the future value of benefits to the present value of costs. It provides an alternative to the Internal Rate of Return (IRR) that avoids some of its mathematical limitations.

2. How Does the Calculator Work?

The calculator uses the ERR formula:

Where:

• \( FV\ Benefits \) — Future value of all benefits (currency)
• \( PV\ Costs \) — Present value of all costs (currency)
• \( n \) — Number of years

Explanation: The equation calculates the annualized rate of return by comparing the growth of costs to benefits over time.

3. Importance of ERR Calculation

Details: ERR is particularly useful for comparing investment projects with different cash flow patterns and for situations where reinvestment rates are known or can be reasonably estimated.

4. Using the Calculator

Tips: Enter future value of benefits and present value of costs in currency units, and the time period in years. All values must be positive numbers.

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between ERR and IRR?
A: ERR uses an explicit reinvestment rate (often the cost of capital) while IRR assumes reinvestment at the IRR itself, which can be unrealistic.

Q2: How should I interpret the ERR result?
A: If ERR exceeds your required rate of return or cost of capital, the investment may be worthwhile. Higher ERR indicates better returns.

Q3: What are the limitations of ERR?
A: ERR requires estimating future cash flows and choosing an appropriate reinvestment rate, both of which involve uncertainty.

Q4: Can ERR be negative?
A: Yes, a negative ERR indicates the investment's benefits don't cover its costs when considering the time value of money.

Q5: When is ERR most useful?
A: ERR is particularly valuable for comparing mutually exclusive projects with different sizes or timing of cash flows.