Minimum Rate of Return (T.R.E.M.A.)

Before getting into the topic of Minimum Return rate TREMA, it is necessary to define or know what the rate of return is.

The rate of return is the income defined as profit or loss on an investment in a given period of time. It is expressed as a percentage of the investment paid.

Investment income is the earned income from the investment. Likewise, the capital gain obtained after the sale of the investment can be added, in the event that a sale occurs after the investment.

The rate of return is also known as the net amount resulting from the cash flows, already discounted, from the investment.

Minimum Rate of Return (T.R.E.M.A.)

It is known in three different ways:

• TMAR Minimum acceptable rate of return.
• TIMA Minimum interest rate.
• TREMA Minimum acceptable interest rate.

It is defined as the rate that represents a profitability weighting, the minimum measure that will be required to reach for make an investment in a certain project, in such a way that it allows to recover the entire investment initial.

It is also handled as an update rate, being an essential element for the financial evaluation of any investment project. For this, it is necessary to have data related to income, expenses, costs, taxes, interests, among others.

TREMA or update rate

It symbolizes a measure of income, the minimum that is expected to be obtained from the project where it is going to be invested, in such a way that it allows to cover:

• The return on the entire initial investment.
• Percentage of return on invested capital or return on investment.
• Payment of taxes.
• The expenses generated during or after the initial investment in the project.
• Interest payable to investment partners in the project.
• The expected return on the principal investor's capital investment.

Considerations when establishing the TREMA

When establishing said minimum acceptable rate of return, it can be done through the following options:

1. Considering the inflation index plus a premium for incurring the risk of investing the money in said project, in such a way that the formula is expressed as follows:

MARR = inflationary index (inflation) + risk premium

1. Another way to calculate it is by using the TIIE (Interbank Equilibrium Interest Rate), adding a risk premium to it, expressed as follows:

TREMA = TIIE + risk premium

If the investor speaks of Risk Premium, he refers to the growth that he expects to obtain from his investment above inflation, that is, the risk premium indicates the development of the capital invested in the business.

It is worth noting that the reference rate used as the basis for comparison and calculation of the economic evaluations is the one that corresponds to the banking entities.

A higher TREMA means that the company expects more from the project.

Risk to the rate of return

Every entrepreneur who wants to invest or the already established investor seeks and yearns for their capital investment to grow in real terms, this means obtaining a return higher than inflation, this surplus is known as the risk.

When establishing the risk premium, the following considerations are taken into account:

• If the investment risk is high, a higher risk reward is expected than the investment.
• Establishing rates of return of different areas of investment in the stock market.

Limitations of the rate of return.

• A rate of return is applicable to any type of investment, from real estate investments, bond issuance, shares in companies, or works of art, among others. As long as the asset acquired generates a subsequent cash flow.
• Investments are almost always evaluated based on rates of return from previous years, comparable with assets of the same type to establish which may be the most attractive investments or profitable.

Conclution

In theory, the MARR is usually called the rate to be exceeded and is calculated with the intention of maximizing the economic well-being of a company taking into account all the considerations that have just been to mention.

The individual way in which a company typically implements this is unclear, it has often been up for debate. The approach mentioned above is the one popularly used to establish the TREMA.

This is the starting point for the premise that ratifies the investment for having a high number of opportunities to generate this return, also allowing the evaluation of different alternatives.

By saying minimum accepted and including the annual average inflation rate, it means that when it is least expected to recover in the project what is invested plus what is lost due to the effect of inflation, or that gives more result than the interest rate of having the money in a bank.