Return on investment(ROI)

ROI measures the overall effectiveness of management in generating profits with its
available asset
Net profit after taxes

Net profit after taxes plus interest

Net profit after taxes plus interest minus tax saving

ROI= profit
investment
Investment vogue in financial literature as
1. Asset
Total asset, tangible asset, Intangible asset
2. Capital employed
long term liability+ owner equity
=
Networking capital +fixed asset
1. Shareholder equity
Equity shareholder
Preference shareholder

OR Long term funds

-investment

 Categories of ROI
1. Return on asset
2. Return on capital employed
3. Return on shareholder equity

Return on assets (ROA)= Net profit after taxes *100

Average total asset
ROA= Net profit after taxes + Interest * 100
Average total asset

ROA= Net profit after taxes + Interest * 100

Average tangible assets

ROA= Net profit after taxes + Interest * 100

Average fixed assets

ROA= EAT+(Interest Tax advantage on interest) or After tax interest cost

Average total assets/Tangible assets/Fixed assets

Return on Capital Employed(ROCE)

ROCE=

Earning before interest and tax *100

Average total capital employed

ROCE= Net profit after taxes +Interest-Tax advantage on interest *100

Average total capital employed

ROCE=

Net profit after taxes + Interest tax advantage on interest

Average total capital employed

*100

Return on Shareholders Equity

The term shareholder equity includes
1.
Preference share capital;
2.
Ordinary shareholder equity
I.
Equity share capital
II.
Earning per share
III.
Dividends per share
IV.
Dividend pay out ratio
V.
Dividend and earning yield
VI.
Price- earning ratio

Return on Total shareholders Equity

Return on total shareholders' equity=

Return on equity funds=

Earning Per share(EPS)= Net profit available to equity holders

Number of ordinary shares outstanding

Net Profit after taxes

*100

Net profit after taxes-Preference dividend

Average ordinary shareholders equity or net worth

Cash earning Per share= Net profit available to equity-owner +Depreciation+

amortization+ Non-cash experience
Number of equity share outstanding

*100

Book Value Per Share=

Net worth
Number of equity share outstanding

Price to Book Value Ratio=

Dividend per share=

MPS
BPS

Dividend paid to ordinary shareholders

Number of ordinary shares outstanding

Dividend Pay-out (D/P) Ratio= Total dividend (cash dividend) to equity holders *100
Total net profit belonging to equity holders

OR DPS
EPs

Earning and Dividend Yield

Earning yield=

EPS
*100
Market value per share

Dividend yield=

DPS
Market value per share

Price Earning (P/E) Ratio=

*100

Market price of share *100

EPS

ROI has the following advantages:

It relates net income to investment made in division giving better measure of

divisional profitability
It can be used as a basis for other ratios which are useful for analytical
purposes.
It is easy to understand as it is based on financial accounting measurement
It may be used for inter firm comparisons ,provided that firms whose results
are being compared are of comparable size and of same industry

ROI has the following limitations:

Satisfactory definition of profit and investment are difficult to find. Profit
has many concepts such as PBT, PAIT, controllable profit, profit after
deducting all allocated fixed cost. Similarly the term investment may have
many connotations such as gross book value, net book value, historical
coat of asset, current cost of asset, assets including or excluding intangible
assets.
While comparing ROI of different companies it is necessary that the
companies use similar accounting policies and methods in respect of
valuation of stocks, valuation of fixed assets, apportionment of overheads,
treatment of research and development expenditure etc.
ROI may influence divisional manager to select only investments with high
rate of return. Other investment that would reduce the divisions ROI but
could increase the value of business may be rejected by divisional
manager. It is likely that another division may invest the available fund in
project that might improve its exiting ROI but which will not contribute as
much to the enterprise as a whole. These type of decision are sub-optimal
can distort an enterprises overall allocation of resources and can motivate
a manager to make under investing in order to preserve