Cash-on-Cash Return: Method of Yield Computation for Investments

A detailed examination of the Cash-on-Cash Return method, which calculates yield by dividing annual dollar income by the total dollar invested. This entry also explores related measures such as Internal Rate of Return and Yield to Maturity.

Cash-on-Cash Return (CoC Return), also known as the Equity Dividend Rate, is a popular method used to calculate the yield on an investment. It is particularly prevalent in the realms of real estate and other forms of equity investments. The Cash-on-Cash Return is determined by dividing the annual dollar income by the total amount of dollars invested.

How to Calculate Cash-on-Cash Return

To understand Cash-on-Cash Return, let’s look at the formula:

$$ \text{Cash-on-Cash Return} = \frac{\text{Annual Dollar Income}}{\text{Total Dollar Invested}} $$

For example, for a $10,000 investment that pays $1,000 annually:

$$ \text{Cash-on-Cash Return} = \frac{1,000}{10,000} = 0.10 = 10\% $$

Components of the Formula

• Annual Dollar Income: This is the net income generated by the investment during the year, excluding any debt payments.
• Total Dollar Invested: This represents the total equity invested in the project. It typically includes out-of-pocket expenses and initial acquisition costs.

Comparison with Other Measures

Internal Rate of Return (IRR)

• Definition: IRR is a more complex metric that calculates the rate of return at which the net present value (NPV) of all cash flows (positive and negative) from an investment equals zero.
• Sensitivity: IRR accounts for the time value of money and provides a more comprehensive measure when cash flows vary over time.

Yield to Maturity (YTM)

• Definition: YTM is mainly applied to bonds and represents the total return anticipated on a bond if held until it matures.
• Calculation: Unlike Cash-on-Cash Return, YTM includes annual interest payments, par value, and the length of time to maturity.

Historical Context

The concept of Cash-on-Cash Return emerged as a simplified metric for real estate investors to quickly assess potential deals. Real estate investments often involve significant equity components with substantial annual returns making Cash-on-Cash Return a practical initial screen.

Application in Real Estate

Cash-on-Cash Return is particularly useful in real estate investments where initial cash investments are significant, and annual cash flow projections are critical. It assists investors in comparing similar properties and deciding where the best return on equity might be.

Examples in Real Estate

Suppose you’ve invested $50,000 in a rental property which yields $6,000 annually from rent after expenses:

$$ \text{Cash-on-Cash Return} = \frac{6,000}{50,000} = 0.12 = 12\% $$

FAQs

Is Cash-on-Cash Return the same as ROI?

No, Return on Investment (ROI) includes the total return over the life of the investment, including appreciation, whereas Cash-on-Cash Return focuses solely on annual pre-tax cash flow.

Does Cash-on-Cash Return consider mortgage payments?

No, Cash-on-Cash Return calculates returns before any debt payments are considered.

Is a higher Cash-on-Cash Return always better?

Not necessarily. While a higher CoC Return indicates more immediate cash flow, the overall investment viability also hinges on long-term factors such as property appreciation, market conditions, and risk.

Summary

Cash-on-Cash Return offers a straightforward metric for evaluating the immediate financial performance of an investment, especially within real estate. By focusing on annual cash income relative to the cash invested, it allows investors to quickly gauge the efficiency of their capital outlay. However, for thorough investment analysis, it is often supplemented by more intricate measures such as Internal Rate of Return (IRR) and Yield to Maturity (YTM).

References

• Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance. McGraw-Hill Education.
• Geltner, D., Miller, N. G., Clayton, J., & Eichholtz, P. (2013). Commercial Real Estate Analysis and Investments. OnCourse Learning.