Return on Investment | Formula, Calculation & Analysis - Chapter 11

Annualized ROI Formula:

(Ending Value / Beginning Value) ^ (1 / # of Years) - 1

(Ending Value / Beginning Value) ^ (1 / # of Years) - 1

Called annualized ROI, it takes into account time periods between the initial investment and the sale of the investment.

Rate of Return (ROR)

Current Value-Initial Value/Initial Value X 100

Return on investment

Formula used to calculate the potential profit or loss of a particular financial investment or institution

Return on Investment

Net Profit/Total Investment

Profit Margin

Profit (revenue - costs) / Revenue

You just purchased a house at the county foreclosure auction for $100,000. You spent $60,000 in renovations and sold the house for $150,000. What is your ROI?

ROI = Net Profit/Total Investment x 100 ROI = -10,000/160,000 x100 ROI = -.063 x100 ROI = - 6.3%

You purchased some stock a year ago for $10,000. It's now worth only $9,900. You received $200 in dividends. What is your ROI?

ROI = {[Net Income + (Current Value - Original Value)]/Original Value} x 100 ROI ={[200 + (9,900 - 10,000)]/10,000} x 100 ROI = {[200 + (-100)]/10,000} x 100 ROI = {100/10,000} x 100 ROI = 0.01 x 100 ROI = 1%

ROI can be a useful financial tool for determining if an investment will be profitable. It also has some limitations:

ROI can be too simplistic; unless the annualized formula is used, it can be deceiving because it lacks periods of time. ROI can be manipulated by people presenting the information because it can be calculated without including expenses incurred after the initial investment.

(Final Value of Investment-Initial Value Investment)/Total Cost of Investment X 100

This ROI takes into account any expenses that occur after the initial investment

Net Profit/Initial Investment X 100

This traditional ROI only takes into account the initial cost of the investment compared to the return.