Risk adjusted return on Capital (RAROC)

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Definition: Risk adjusted return on Capital (RAROC)

Risk adjusted return on capital tells us the return on the capital invested in a project after the income is adjusted for the risk component associated with the project.

Different projects have different level of risks associated with them. This risks sometimes results in less cash flows from a particular project. In RAROC we separate the riskier cash flows from non-riskier cash flows by discounting it. The formula for RAROC is given below:

RAROC = ( Income – expected loss + Income from Capital)/ Capital

 

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