What is Return on Investment? Description
ROI is an accounting valuation method. The ROI is a return ratio that compares
the net benefits of a project, versus its total costs. For example, if a project
has an ROI of 300%, the net benefits derived from that project are three times
those of the expected total costs to implement the project. As such, the ROI
calculation represents the relative value of the project's cumulative net
benefits (benefits minus costs) over the analysis period, divided by the project's
cumulative total costs, and expressed as a percentage.
Because the numerator (Net Income) is an unreliable corporate performance
measurement, the outcome of the formula for ROI must also be unreliable to
determine success or corporate value. However the ROI formula still shows
up in many annual reports...
Return on Investment overstates economic value
The degree to which ROI overstates the economic value depends on at least
- Length of project life. If this is longer, the overstatement
will be bigger.
- Capitalization policy. If the fraction of total investment capitalized
in the books is smaller, the overstatement will be bigger.
- Rate at which depreciation is taken in the books. Depreciation
rates that are faster than straight-line basis will result in a higher ROI.
- Lag between investment outlays and earning back these outlays
from cash inflows. If the time lag is greater, the degree of overstatement
will also be greater.
- Growth rate of new investment. Fast growing companies will have
lower Return On Investment.
Calculation of Return on Investment. Formula
Net Income / Book Value of Assets = ROI
A better alternative is:
Net Income+Interest (1-Tax Rate) / Book value of Assets = ROI
Book: Steven M.
Bragg - Business Ratios and Formulas : A Comprehensive Guide -
Book: Ciaran Walsh
- Key Management Ratios -
Return On Investment Special Interest Group
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Compare with Return on Investment: EBIT
| EBITDA |
Total Cost of Ownership |
Relative Value of Growth
| Economic Value Added |
Earnings Per Share |
Return on Equity |
Net Present Value |
Return On Net Assets |
Return on Invested Capital |
Return to Management Hub: Decision-making & Valuation | Finance & Investing
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