Describe the two ways ROI can be calculated.

Short Answer

Expert verified

Two ways to calculate ROI are as follows:

ROI=NetIncomeCostofinvestmenntROI=InvestmentgainInvestmentbase

Step by step solution

01

Meaning of ROI

ROI can be a metric used to evaluate the effectiveness or productivity of investment. When deciding the return on investment (ROI) for a particular investment or speculative, divide by the value of the return or return from the initial investment.

02

The two ways to calculate ROI

Operating income divided by average total assets is the return on investment. The calculation components are more clearly displayed in the ROI equation's extended version. The formula is as follows:

1.ROI=NetIncomeCostofinvestment2.ROI=InvestmentgainInvestmentbase

The most widely used ratio is the first iteration of the ROI formula, which is net income divided by the cost of an investment.

The simplest method to understand the ROI formula is to divide some "benefit" by the "expense." Asking someone to specify precisely how they measure something's ROI is vital when they claim it is good or terrible.

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Most popular questions from this chapter

What does ROI measure?

How does capacity affect transfer pricing decisions?

XTreme Sports Company makes snowboards, downhill skis, cross-country skis, skateboards, surfboards, and inline skates. The company has found it beneficial to split operations into two divisions based on the climate required for the sport: Snow Sports and Non-snow Sports. The following divisional information is available for the past year:

Net Sales Revenue

Operating Income

Average Total Assets

ROI

Snow Sports

\(5,500,000

\)990,000

$4,100,000

24.1%

Non-snow Sports

8,500,000

1,530,000

6,100,000

25.1%

XTreme’s management has specified a 13% target rate of return. Calculate each division’s profit margin ratio.

Interpret your results.

What are some limitations of financial performance measures?

Zims, a national manufacturer of lawn-mowing and snow-blowing equipment, segments its business according to customer type: professional and residential. The following divisional information was available for the past year:

Net Sales Revenue Operating Income Average Total Assets

Residential \( 550,000 \) 65,280 $ 192,000

Professional 1,090,000 164,820 402,000

Management has a 26% target rate of return for each division.

Requirements

1. Calculate each division’s ROI. Round all of your answers to four decimal places.

2. Calculate each division’s profit margin ratio. Interpret your results.

3. Calculate each division’s asset turnover ratio. Interpret your results.

4. Use the expanded ROI formula to confirm your results from Requirement 1. What can you conclude?

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