Return on Investment (ROI)

ROI is a metric used to measure the profitability of an investment or an expenditure. It is calculated by dividing the net return on investment by the cost of investment and multiplying it by 100%.

Formula:

ROI = (Net Return on Investment / Cost of Investment) x 100%

Net Return on Investment:

• The net return on investment is the total return generated by the investment, including any cash flows, dividends, or capital appreciation, minus any costs or fees associated with the investment.

Cost of Investment:

• The cost of investment is the initial cost of acquiring the asset or making the investment. This includes any fees, commissions, or other expenses incurred during the investment process.

Types of ROI:

• Cash ROI: Measures the return on investment in terms of cash flow, such as the return on investment for a bank loan or a bond.
• Asset ROI: Measures the return on investment in terms of asset value, such as the return on investment for stock investments.
• Discounted ROI: Measures the return on investment by calculating the present value of future cash flows.

Examples:

• An investor buys a stock for $10,000 and sells it for $12,000 a year later. The investor receives a dividend of $2,000 during the year. The total return on investment is:

ROI = (2,000 + 2,000) / 10,000 x 100% = 20%

• A company invests $100,000 in a new machine and expects to save $20,000 in annual costs. The return on investment is:

ROI = 20,000 / 100,000 x 100% = 20%

Benefits:

• Provides a clear and concise measure of investment performance.
• Allows for comparison of different investments or expenditures.
• Can help investors make informed decisions about future investments.

Limitations:

• Can be difficult to measure accurately, especially for long-term investments.
• May not be suitable for investments with complex financial structures.
• Can be influenced by external factors beyond the investor’s control.