Return on investment, also known as ROI, is a performance measure use to evaluate the efficiency of an investment on its own, or in comparison with a number of other investments. Without much ado, let us get into the calculation of return on investment; but first, the formula
ROI = ((Gain from investment cost-Cost of investment))/(Cost of investment)
Gain of investment = returns obtained from the investment
Cost of investment = how much it cost for set up
If John invested $1000 in a fish farm and sole his shares for a total of $1200 just one year later, what will be the return on his investment?
Gain from investment = $1200
Cost of investment = $1000
ROI = ((1200- 1000))/1000
The return on investment for John’s investment on the fish farm was 20% after a period of one year. With this information, he can compare the profitability of the fish farm investment and that of other opportunities, and can decide to either stick with it or go for other ones.
If you buy 20 shares of Jane’s fashion shop for $10 per share at an investment cost of $200, and you end up selling those shares at $15 per share, what will be your rate of return on this investment?
Gain from investment = $300
Cost of investment = $200
ROI = ((300-200))/200
This is a pretty good one. You made a return on investment of 50%.
ROI is just one out of many other profitability ratios used in calculating the return of an investment. The formula is pretty straight forward, and anyone with no prior knowledge of this sort of calculations can simply substitute and get the answer. However, this method of calculating return on investments has its downside – it can be manipulated. As such, results can vary between users. Basically, using the same input with this particular method returns the same results.
Another thing noteworthy of this calculation method is that it does not take time into consideration. This makes it an incomplete analysis for an investor to base his or her decisions. An investor wants to know how long it will take to get a certain amount of return on his or her investment. Making a return of 20% in one year is more desirable than making the same rate in three years.
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