The various types of investors in a company take different levels of risk exposures and expect different levels of financial returns. All the long-term strategic investors in a company including the lenders expect a good strategic financial performance from a company. They have the last rights on the income proceeds of a company. Hence, if a company is able to reasonably honour or fulfill the expectations of these strategic investors, it can be said that the company’s overall financial performance is good. The expectation of the the long-term strategic investors is expressed in terms of post-tax rate of return on capital. The creditors would be happy if the company is able to serve the debt in a timely manner. They have an expectation of fixed, minimum guaranteed and periodic return and they are not interested in the upside of the company performance.
The situation of equity investors is a little different. They expect much more from upside. Even though the financial statements are computed monthly, quarterly or annually, the time horizon of equity investment is much higher. They are interested in the overall performance during this entire period. So, it divides the the return on equity investment in two parts:
1. The return on investment that has been realised so far (rate of return on equity in the nature of dividend yield).
2. The potential for return on investment that has been created and which can be realised in the future. The confidence with which it can be transferred to an interested person in case the equity investor (here, the businessman) wants to exit. It is measures in the form of the projected internal rate of return which is reflected in the form of appreciation in share price.