return on investment

(noun)

ROI. The dollar return of the investment divided by the initial value.

Related Terms

Examples of return on investment in the following topics:

  • Reporting Investing Activities

    • Cash flows due to changes in non-current assets or returns on investments must be determined to be inflows or outflows in order to be reported properly.
    • An investing activity is anything that has to do with changes in non-current assets -- including property and equipment, and investment of cash into shares of stock, foreign currency, or government bonds -- and return on investment -- including dividends from investment in other entities and gains from sale of non-current assets.
    • These activities are represented in the investing income part of the income statement.
    • However, this cash flow is not representative of an investing activity on the part of the company.
    • The sale of a factory would be an example of a cash inflow from investment.

  • Percentage Returns

    • Percentage returns show how much the value of the investment has changed in proportion to the size of the initial investment.
    • The conventional way to express the return on a security (and investments in general) is in percentage terms.
    • This is because it does not only matter how much money was earned on the investment, it matters how much was earned in proportion to the cost.
    • When the length of time of the investment is one year, the total and annual returns are equivalent.
    • This type of return is also called the return on investment (ROI), where the numerator is the dollar return.

  • Cash Flow from Investing

    • An investing activity is anything that has to do with changes in non-current assets -- including property and equipment, and investment of cash into shares of stock, foreign currency, or government bonds -- and return on investment -- including dividends from investment in other entities and gains from sale of non-current assets.
    • However, this cash flow is not representative of an investing activity on the part of the company.
    • Cash inflow resulting dividends paid on stock owned in another company.
    • It is important to remember that, as with all cash flows, an investing activity only appears on the cash flow statement if there is an immediate exchange of cash.
    • Therefore, extending credit to a customer (accounts receivable) is an investing activity, but it only appears on the cash flow statement when the customer pays off their debt.

  • Calculating and Understanding Average Returns

    • The average return of an investment can be calculated a number of ways.
    • To calculate the total ROI of an investment, simply divide the total dollar returns of the investment by the initial value.
    • If the only source of return on a bond is the coupon payments, then this is an accurate method.
    • CAGR is very useful for finding the rate of return that the investment would have to earn every year for the life of the investment to turn the initial value into the future value over the given time frame.
    • Differentiate between the different methods for calculating the average return of an investment

  • Defining the IRR

    • IRR is a rate of return used in capital budgeting to measure and compare the profitability of investments; the higher IRR, the more desirable the project.
    • The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investments.
    • It is also called the "discounted cash flow rate of return" (DCFROR) or the rate of return (ROR).
    • The internal rate of return on an investment or project is the "annualized effective compounded return rate" or "rate of return" that makes the net present value (NPV as NET*1/(1+IRR)^year) of all cash flows (both positive and negative) from a particular investment equal to zero.
    • Showing the position of the IRR on the graph of NPV(r) (r is labelled 'i' in the graph).

  • Defining the Payback Method

    • A $1000 investment which returned $500 per year would have a two year payback period.
    • In capital budgeting, the payback period refers to the period of time required for the return on an investment to "repay" the sum of the original investment.
    • An implicit assumption in the use of the payback method is that returns to the investment continue after the payback period.
    • Start by calculating net cash flow for each year: net cash flow year one = cash inflow year one - cash outflow year one.
    • The payback method is a simple way to evaluate the number of years or months it takes to return the initial investment.

  • Types of Financial Decisions: Investment and Financing

    • An investment decision revolves around spending capital on assets that will yield the highest return for the company over a desired time period.
    • Since there is no guarantee of a return for most investments, the finance department must determine an expected return.
    • This return is not guaranteed, but is the average return on an investment if it were to be made many times.
    • If there is no investment opportunity that fills (1) and (2), the cash must be returned to shareholder in order to maximize shareholder value.
    • Taking on debt is the same as taking on a loan.

  • Defining the Cost of Capital

    • The cost of capital is the rate of return that could be earned on an investment with similar risk.
    • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
    • The cost of capital can be compared to the internal rate of return (IRR) of a project or investment.
    • IRR is the rate of return that makes the net present value of all cash flows from an investment equal zero.
    • A graph showing the decision between two exclusive investments based on IRR.

  • Differences Between Required Return and the Cost of Capital

    • The terms "required return" and "cost of capital" essentially denote the same opportunity cost of choosing one investment over another.
    • When we speak of cost of capital, we are referring to the expected returns on all of the various securities issued by a company, often expressed as a weighted average.
    • However, since required return is from the investor's point of view, it refers to the rate of return necessary to compensate investors for taking on the risk of the individual investment.
    • Instead of taking into account all types of securities issued by a firm, an investor acquires the appropriate required return by taking the risk-free rate and adding an investment specific risk premium.
    • In the absence of debt, shareholders are confronted with one form of risk–business risk.

  • Implications for Expected Returns

    • The expected return of a diversified portfolio is the expected return of each of its underlying investments times the weight the investment receives.
    • The first is that everything goes in cycles and the second is that often when one things is ebbing, the other is flowing.
    • Stocks have a good year and bonds have a bad one, and now we have $69,000 invested in stocks and $41,600 in bonds.
    • Look at how the different asset mixes fare, based on a 10-year period that is consistent with historical averages.
    • Assuming rebalancing, the expected return of a diversified portfolio is simply the expected return of each of its underlying investments times the allocation weight the investment receives.