Target Return

What Is Target Return?

A target return is a pricing model that prices a business based on what an investor would need to make from any capital invested in that company.

Understanding Target Return

Target return is calculated as the money invested in a venture, plus the profit that the investor needs to find in return, adjusted for the time value of money (TVM). As a return-on-investment (ROI) method, target return pricing requires an investor to work backward to come to a current price.

One of the major challenges in utilizing this pricing method is that an investor must pick both a return that can be sensibly attained, as well as a time span in which the target return can be reached. Picking a high return and a short time span means that the venture must be significantly more profitable in the short-run than if the investor expected a lower return over a similar period, or a similar return over a more drawn out period.

Target return can likewise be utilized to project the price a company ought to set on its product sales to create an ideal profit. This model assumes that the company will actually want to accomplish the projected sales volume to arrive at the target return. On the off chance that real sales miss the mark, the pricing would need to be adjusted to accomplish the target.

For example, an electric lamp company could set a target return of 15% on $10 million that was invested into the development of another spotlight. The manufacturing cost per unit is $12, and the company hopes to sell somewhere around 70,000 units inside the predefined time period. That means each new spotlight would should be priced at $33.43 and up to deliver the looked for return.

The target return model contrasts to some degree from a cost-plus pricing strategy, wherein the price markup is based on different criteria. The cost of delivering the product is the primary factor, with an extra profit margin made by setting the price higher. Time and expected volume of sales don't play a part in this price model. All things being equal, the company decides the amount it needs to earn from the product it sells, without consideration of any investments into the company or the development of the product.

Another model, value-based pricing, works from the other way. This beginnings with the value the company appoints to the product and afterward attempts to change the costs of production to accomplish profitability.

Highlights

• Commonly, investors work backward from the expected target return to arrive at a current price.
• Target return is not quite the same as the cost-plus-pricing model in which a product's manufacturing costs are added up and a markup is added.
• Target return is not the same as other pricing models since it requires into account the investment value of money.
• A target return alludes to the future value, or profit, that an investor anticipates from their investment.