PRESENTATION ON

RETURN ON INVESTMENT(ROI)

PREENTED BY

DHAVAL SHUKLA
JASKARAN SINGH
 RATE OF RETURN
 RATE OF RETURN ALSO KNOWN AS RATE OF RETURN OR RATE
OF PROFIT.

 IT IS A KIND OF FINANCIAL MEASURE FOR THE MEANS OF

FINANCIAL ANALYSIS.

 IT IS THE RATIO OF MONEY GAINED OR LOST (WHETHER

REALIZED OR UNREALIZED) ON AN INVESTMENT RELATIVE TO
THE AMOUNT OF MONEY INVESTED.

 THE AMOUNT OF MONEY GAINED OR LOST MAY BE REFERRED

TO AS INTEREST,, GAIN/LOSS, OR NET INCOME/LOSS.
 THE MONEY INVESTED MAY BE REFERRED TO AS THE ASSET,
CAPITAL, PRINCIPAL, OR THE COST BASIS OF THE
INVESTMENT. ROI IS USUALLY EXPRESSED AS A
PERCENTAGE RATHER THAN A FRACTION.

 MARKET FORCES DETERMINE THIS RATE

 PEOPLE’S WILLINGNESS TO PAY THE DIFFERENCE FOR

BORROWING TODAY AND THEIR DESIRE TO RECEIVE A
SURPLUS ON THEIR SAVINGS GIVE RISE TO AN INTEREST
RATE REFERRED TO AS THE PURE TIME VALUE OF MONE.
 PURPOSE

IT IS USEFULL FOR FOLLOWING PURPOSES

 TO JUSTIFY SPENDING.

 TO IMPROVE THE PRODUCTIVITY AND GAIN.

 FORCASTING SUCCESS OF A NEW PROJECT.

 TO COMPARE THE PROFITABILITY OF TWO PROJECTS

 HOW WE CAN CALCULATE ROI?

 The return on investment formula:

(GAIN FROM INVESTMENT)-(COST OF INVESTMENT )

(COST OF INVESTMENT)

Return on investment is a very popular metric because of its

versatility and simplicity.

 That is, if an investment does not have a positive ROI, or if there are
other opportunities with a higher ROI, then the investment should not be
undertaken.
 ROI has a distinct advantage over income as a measure of performance since it
considers both income (the numerator) and investment (the denominator).

ROI = Income
Invested capital

Profit Margin Investment Turnover

ROI = Income Sales

x
Sales Invested capital
The breakdown of the formula shows that managers can increase return by more profit
and/or generating more sales for each investment Rs.
CONT……
 If the future payment will be diminished in value
because of inflation, then the investor will demand
an interest rate higher than the pure time value of
money to also cover the expected inflation expense.
 DETERMINANTS OF
REQUIRED RATES OF RETURN

 Time value of money during the period of

investment.

 Expected rate of inflation during the period.

 Risk involved.
 ROI METHODOLOGY PROCESS
MODEL
EVALUATION PLANNING DATA COLLECTION

COLLECT CONVERT
PLAN COLLECT
DEVELOP DATA DATA TO
EVALUATIO DATA AFTER
OBJECTIVES DURING MONETORY
N PROJECT
PROJECT VALUE

DATA ANALYSIS REPORTING

TABULATE
ANALYSIS
FULLY CALCULAT REPORT
OF THE
LOADED E ROI RESULTS
RESULTS
COSTS
 EXAMPLE

Investment A Now Year 1Year 2Year 3Year 4Year 5Total

Cash Inflows A 0 40 50 75 95 105 355
Cash Outflows A 100 20 20 35 25 25 225
Net Cash Flow A –100 20 30 40 70 80 140
Cumulative CF A –100 –80 –50 –10 60 140
----------------------------------------------------------------------------------------------------
Simple ROI A -100.0% –66.7% –35.7% –5.7% 30.0% 62.2%

For Investment B... Investment B Now Year 1Year 2Year 3Year 4Year 5Total
Cash Inflows B 0 100 90 75 50 40 355
Cash Outflows B 100 30 30 35 20 20 235
Net Cash Flow B –100 70 60 40 30 20 120
Cumulative CF B –100 –30 30 70 100 120
-------------------------------------------------------------------------------------------------
Simple ROI B -100.0% –23.1% 18.8% 35.9% 46.5% 51.1%
 Example analysis………
Considering the 3-year ROIs from each investment, clearly B's ROI of
35.9% is better than A's ROI of –5.7%.

Considering the 5-year ROIs however, investment A clearly has the

higher ROI at 62.2%, vs. 51.1% for B's five-year ROI.

It shows for most business investments there is not a single ROI for the
investment, independent of the time period.
 So, it includes the assumption, "Other things being
equal, the investment with the higher ROI is the
better business decision."
 However, important business decisions are rarely
made on the basis of one financial metric and with
business investments, moreover, the condition
"other things being equal" almost never applies.
FACETS OF FUNDAMENTAL RISK

 Business risk
 Financial risk
 Liquidity risk
 Exchange rate risk
 Country risk
FINANCIAL RISK
 Uncertainty caused by the use of debt
financing.
 Borrowing requires fixed payments which
must be paid ahead of payments to
stockholders.
 The use of debt increases uncertainty of
stockholder income and causes an increase in
the stock’s risk premium.
 LIQUIDITY RISK

 Uncertainty is introduced by the

secondary market for an investment.
• How long will it take to convert an
investment into cash?
• How certain is the price that will be
received?
 EXCHANGE RATE RISK
 Uncertainty of return is introduced by acquiring
securities denominated in a currency different from
that of the investor.

 Changes in exchange rates affect the investors

return when converting an investment back into the
“home” currency.
 COUNTRY RISK
 Political risk is the uncertainty of returns caused by
the possibility of a major change in the political or
economic environment in a country.

 Individuals who invest in countries that have

unstable political-economic systems must include a
country risk-premium when determining their
required rate of return
RETURN=RISK FREE RATE+RISK PREMIUM

RISK FREE RATE RISK PREMIUM

 FIX AMOUNT THAT WE ARE  CONSIDERATION FOR THE

GOING TO GET RISK PERCEIVED BY THE
INVESTOR IN THAT ASSET OR
SECURITY.
THE REAL RISK FREE RATE (RRFR)

 Assumes no inflation.
 Assumes no uncertainty about future
cash flows.
 Influenced by time preference for
consumption of income and investment
opportunities in the economy
RISK PREMIUM

f (Business Risk, Financial Risk, Liquidity Risk,

Exchange Rate Risk, Country Risk)
or
f (Systematic Market Risk)
 FUNDAMENTAL RISK
V/S
SYSTEMATIC RISK

 Fundamental risk comprises business risk, financial

risk, liquidity risk, exchange rate risk, and country
risk.

 Systematic risk refers to the portion of an

individual asset’s total variance attributable to the
variability of the total market portfolio
RELATION BETWEEN RISK AND RETURN

Ra teof Re turn
Low Ave ra ge High S e curity
Ris k Ris k Ris k Ma rke t Line

The s lope indica te s the

RFR re quire d re turn pe r unit of ris k

Ris k
(bus ine s s ris k, e tc., or s ys te ma tic ris k-be ta )
 EVALUATION OF VARIOUS INVESTMENT AVENUES

Return Marketability/
Current yield Capital Risk Liquidity Tax Shelter Convenience
appreciation
Equity
Low High High Fairly high High High
Shares
Non-
convertible High Negligible Low Average Nil High
Debentures
Equity
Low High High High High Very high
Schemes
Debt No tax on
Moderate Low Low High Very high
Schemes dividends
Bank
Moderate Nil Negligible High Nil Very high
Deposits
Public
Moderate Nil Section 80 C
Provident Nil Average Very high
benefit
Fund
Life
Nil Section 80 C
Insurance Nil Moderate Average Very High
benefit
Policies
Residential
Moderate Moderate Negligible Low High Fair
House
Gold and
Nil Moderate Average Average Nil Average
Silver
 PROBLEMS WITH USING ROI

Investment in assets is typically measured using historical cost.

ROI becomes larger as assets become depreciated. This may result
in managers taking unnecessary delays in updating equipment.
 Managers may turn down projects with positive net present values, simply
because accepting the project results in a reduced ROI. In other words, projects
may be turned down if they provide a return above the cost of capital but below
the current ROI.

 IGNORES CASHFLOWS : ROI uses accounting profits & not cashflow. so, it
becomes inappropriate to rely on them for measuring the acceptability of the
investment projects.

 IGNORES TIME VALUES : So, it gives larger values than the actual.

 CONSIDERS BOOK VALUES OF ASSETS : Because of this the growth

companies earnings very high rates on their existing assets may reject profitable
projects and the less profitable companies may accept bad projects .
 CONCLUSION

ACCOUNTI ROI can be readily calculated from the accounting data,

●

unlike in the NPV and IRR methods, no adjustments are

NG DATA required to arrive at cash flows of the project.

SIMPLICIT The ROI method is simple to understand and

●

use. It does not involve complicated

Y computations.

The ROI method incorporates the entire

ACCOUNTING
●

stream of income in calculating the projects

PROFITABILITY profitability.