Rate of Return or Return on Investment (ROI) is the ratio of capital earned or lost in relation to the amount of capital invested on certain project. The amount of capital earned or lost is termed as profit or interest, while the investment is termed as capital, principal or asset. More theoretically, the estimation of ROI involves dividing the Net Profit by Net Worth. In general, expression of Rate of Return is depicted through Percentage symbol. Remember, ROI entails both gains and losses earned on the capital invested in the earlier period, current period and for the future.
Calculation of Return on Investment involves estimation of past or present investments, or determining returns on the future investments. ROI does not depict the period of investment. Return on Investment, Rate of Profit or Rate of Return is the prospective stream of cash flow or income from an invested resource. This prospective stream of cash flow or income comes from dividends, capital gains, or interest. In general, a capital gain happens when the stock market value of any investment falls or rises. However, it does not include the return gained on the specific investment.
Return on Investment Estimation:
Return on Investment is arithmetically is represented as Vf / Vi -1. Where, Vf signifies ultimate investment value and Vi denotes the preliminary investment value. Return on Investment is beneficial when the Vf / Vi -1 > 0 and is deemed to be unbeneficial when the ultimate investment value is below the value of preliminary investment.
In a dynamic sense, Yield is the original Return on Investment. Yield is based on the CI (compound Interest) rates estimated, when the investment value constantly changes over a time. Yield captures the reinvesting interest or dividends. Generally, academics use continuous compound return or natural log return for their research purposes. APY (Annual Percentage Yield) or EAR (Effective Annual Rate) implies yearly yields, if estimated by means of compound interest.
In business lines, ROI is the firm’s capacity to make use of its wealth to make extra returns for its stakeholders. Returns on assets or returns on equity are widely used by fiscal analysts to estimate the company’s profitability than other companies. Estimation of a net present value, profitability index, or internal return on investment, helps to select risk free assignments or projects that would bring maximum return for the stakeholders. These estimations come under the arena of capital budgeting methods, where the investments that are more speculative have the prospective to generate the higher returns.
Usually, return on investments or investment returns get discount for factors such as taxes and inflations that give the actual worth of the return on investments. Investments generate incomes for the investors to compensate the time value of the money.
Finally, Rate of Return or Return on Investment is an essential part of cost benefit evaluation for prospective projects and those, which have far reaching consequences on the progress of a country or a region. Rate of Return estimations are generally used for individual’s financial decisions such as Annualized Rate of Return and Annual Rate of Return.