In every business one is involved with, it is important to know how to calculate the rate of return on investment. This can go a long way to give the investor a clear and general picture of how good or bad the investment is doing. In this article, the focus will be on the following talking points
What is rate of return on investment?
How to calculate the rate of return on investment
WHAT IS RATE OF RETURN ON INVESTMENT?
Simply put, rate of return on investment is how much gain or loss an investment has made over a specific period of time. It is a way of evaluating the efficiency of the strategy in use. Efficiency is a very important factor in all investments. It is about the level of performance or work being done to ensure maximum output in an investment. A performance is said to be efficient if it requires a minimal amount of input to produce a relatively maximized output.
Rate of return on investment is expressed in percentage regarding the cost of investment. Income received and any capital gain that may be realized from goods and services offered by the investment within a specified period of time is defined as the “gains”.
RATE OF RETURN AND DISCOUNTED CASH FLOW (DCS)
From another point of view, rate of return on investment can be defined as the net amount of discounted cash flow received on an investment. Just like measuring the efficiency of the strategy employed for an investment, discounted cash flow is used to evaluate the attractiveness of an investment opportunity. If the result of a DCF analysis is higher than the current cost of the investment, then such investment is said to be a good one. With this, investors can tell when and when not to invest in a venture.
CALCULATING RETURN ON INVESTMENT
The aim of this calculation is to measure the amount of return on an investment as it relates with the cost of investment. To carry out this calculation, you will need the value of the following
- GAIN FROM INVESTMENT:
Gain of investment is the profits from the investment within the period of time of interest. The value may be more than the cost of investment or less than; it does not really matter.
- COST OF INVESTMENT:
This is what it took to set up the investment in all ramifications. Right from the development stage, executions and operational stages are all accounted for.
The formula for calculating rate of return on investment is
Rate of investment = (gain of investment – cost of investment) ÷ cost of investment
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