If you handle the accounting or finances of a company, it is very likely that you have ever come across the Fisher rate. It is a tool that puts two projects "face to face" to find out which is the most convenient when deciding to invest in one of them.
But what else do you know about this rate? Have you learned to calculate it? If not, and you would like to have that knowledge, Here we explain everything you need to know about it. Go for it?
What is the Fisher rate
As we have told you before, The Fisher rate is a tool with which two investment projects can be pooled (as long as both can be compared, of course) to see which of the two is more worthwhile.
We give you a basic example (and grosso modo). Imagine that you have a marketing agency that is starting. And you get two projects. Right now you can't do both, but each has its advantages and disadvantages. How do you choose then? Well The rate could be applied to know where to invest your efforts to know a greater profitability.
What elements does the Fisher rate use?
To apply Fisher's rate to two projects, you must know that there are two essential elements to obtain a result. On the one hand, there is the VAN, that is, the net present value. Or, in other words, the value that this project can have at that moment; on the other hand, there is the TIR, which is the interest rate that cancels the VAN.
And what does that give us? Once you know both the VAN and the IRR of both projects, this is shared, usually in a line graph. It is a "minimum" and the project that has the NPV line above that cutoff rate would be the winner in the comparison.
What is the Fisher rate formula
Here we must tell you that there is really no analytical formula for you to calculate it. Actually, two ways of calculating it are used:
with linearization
As we have told you before, Fisher's rate is represented by a line graph. Therefore, the TIR and VAN lines are drawn at 0%. A straight line is drawn between the two points of each project.
There is another way to do it and that is by giving it the at value of 10% and thus calculating the GO at that point with GO 0% and known IRR.
Keep in mind that the VAN formula is available, which would be:
VAN = Updated Net Profit (BNA) – Initial Investment (lo)
This formula can give you three results:
- = 0. Which means that you will not obtain benefits, but neither losses.
- > 0. When there will be profitability (benefits).
- < 0. Which implies that there will be losses in the project.
In the case of IRR, it also has a formula, although this is much more complex and is not easy to calculate. The IRR obtains what we could call “opportunity cost”, and again we find three results:
- = 0. Which implies that the project is not good because the risk will not obtain a satisfactory result.
- > r (opportunity cost). It means that the project is viable and has a chance of being approved.
- <r. It implies that the project has no possibilities mainly because it is not profitable enough for it.
Using Excel
This is the most common and fastest form of calculation since the program can offer a much faster formula and apply it to the data that is available. In order to apply it, the cell where the result will appear must be selected and click on Insert function. Next, in the functions group you must select Statistics, and there “Fisher function”. You will have to put the required number (it will always be a value greater than -1 and less than 1).
Is the Fisher rate reliable?
Although the Fisher rate is based on the data of the projects, the truth is that you cannot trust 100% in the results it gives you, since there are other factors that are not taken into account and that will influence the possible results. In other words, it could happen that a rejected project succeeds while the chosen one collapses.
That is why, when making the decision, you must assess other aspects such as the market situation, project investigations...
As you can see, the Fisher rate can be convenient to know and apply when you have several projects in hand and you want to know which one would be the best to invest in. Of course, it entails a bit of research since we are talking about a more technical tool and not too easy to understand (at least at first). Have you ever applied it?