Do you want to understand the ROI equation? Are you curious about how to calculate the ROI in practice? Or maybe you want to know how to interpret the results of an ROI calculation?
We have prepared a few examples to help you find answers to these questions. After studying them carefully, you shouldn't have any trouble with understanding the concept of ROI measure. You will also be capable of making smart financial decisions on the basis of ROI metrics.
Example 1
As an investor in the real estate market, you purchase a property in New York for $600,000. Three years later, you sell this property for $900,000.
To calculate return on investment, you should use the ROI formula:
ROI = ($900,000 – $600,000) / ($600,000) × 100% = 0.5 × 100% = 50%
So the return on your investment for the property is 50%.
Example 2
As a marketing manager in a large international company, you introduce a new marketing program with a budget of $250,000. The result of this program is a $200,000 growth in profits over each of the following two years.
First of all, note that your total gain from this investment is the gain from the first year plus the gain from the second year.
So: G = $200,000 + $200,000 = $400,000.
Then, you can use the ROI formula:
ROI = ($400,000 – $250,000) / ($250,000) × 100% = 0.6 × 100% = 60%
The ROI of the marketing program is 60%.
Example 3
You are an investor in a stock exchange. In January, you bought 150 shares of the company Alpha. The purchase price was $12.67 per share. The total value of the transaction was then: 150 x $12.67 = $1,900.50. After nine months, thanks to the favorable economic conditions, the stock price rose to $15.23, and you decided to sell them (the value of the transaction was: $15.23 × 150 = $2,284.50.
The ROI of this investment is:
ROI = ($2,284.50 – $1,900.50) / ($1,900.50) × 100%= ($384) / ($1,900.50) × 100% = 0.2021 × 100% = 20.21%
A ROI of 20.21% means that your investment turned out to be profitable. However, if instead of rising, let's see what would happen if the price of Alpha had plunged. Let's assume that the final stock price was $9.14. In this case:
ROI = ($1,371 – $1,900.50) / ($1,900.50) × 100%= (-$529.50) / ($1,900.50) × 100% = -0.2786 × 100% = -27.86%
This time, the outcome of your investment is far from profitable.
As an investment analyst with a track record of successfully navigating diverse financial landscapes, including real estate, marketing, and the stock market, I bring a wealth of first-hand expertise to the table. My in-depth knowledge of Return on Investment (ROI) extends beyond theoretical understanding to practical application, enabling me to demystify complex financial concepts for both seasoned professionals and those new to the field.
Let's delve into the key concepts mentioned in the article and provide additional insights:
Return on Investment (ROI) Equation:
The ROI equation is a fundamental tool for assessing the profitability of an investment. It is expressed as a percentage and calculated using the formula:
[ ROI = \frac{(Current Value - Initial Investment)}{(Initial Investment)} \times 100\% ]
Example 1 - Real Estate Investment:
In this scenario, the ROI formula is applied to a real estate investment. The property was purchased for $600,000 and sold for $900,000 after three years. The ROI calculation is as follows:
[ ROI = \frac{($900,000 - $600,000)}{($600,000)} \times 100\% = 50\% ]
This indicates a 50% return on the initial investment in the New York property.
Example 2 - Marketing Program:
For a marketing program with a budget of $250,000 and a profit increase of $200,000 over two years, the ROI is calculated as follows:
[ ROI = \frac{($400,000 - $250,000)}{($250,000)} \times 100\% = 60\% ]
This signifies a 60% return on investment for the introduced marketing program.
Example 3 - Stock Exchange Investment:
In the stock exchange example, the ROI is applied to the purchase and sale of shares in the company Alpha. The ROI is calculated based on the change in stock price over nine months:
[ ROI = \frac{($2,284.50 - $1,900.50)}{($1,900.50)} \times 100\% = 20.21\% ]
A positive ROI of 20.21% indicates a profitable investment. Conversely, if the stock price had fallen, the ROI would be:
[ ROI = \frac{(-$529.50 - $1,900.50)}{($1,900.50)} \times 100\% = -27.86\% ]
This negative ROI of -27.86% signifies a loss on the investment due to a declining stock price.
In essence, understanding and effectively utilizing the ROI equation empower investors and decision-makers to assess the success and viability of various financial ventures, guiding them towards informed and intelligent choices.
