ROI and Annualized ROI
This calculator can be used to quantify a gain or loss on investment, as well as the overall return on investment (ROI) and annualized ROI. To do this, the calculator requires four inputs:
- The amount of the original investment
- The start date of the investment using the format mm/dd/yyyy
- The returned value, which is the total value of the asset at the end of the investment timeline
- The investment end date using the format mm/dd/yyyy
The calculator then provides the user with the following information:
- The total gain or loss on the investment
- The investment term, which is the total timeframe between the start and end date, stated in years
- The total return on investment (ROI)
- The simple annualized ROI, which is the total ROI divided by the investment term
Calculating Investment Profitability
Return on investment, or more commonly ROI, is one of several metrics financial analysts use to determine the profitability of an investment. Similar metrics include internal rate of return, payback, net present value, and total cost of ownership. ROI is calculated by taking the gain or loss on the investment and dividing it by the original investment value. Generally, positive values represent a gain on an investment, while a loss is indicated by negative values. Gains will always have ROI values that are positive, while losses will have negative ROI values.
The Importance of Annualized ROI Values
While understanding an investment’s ROI is important, it is equally important to understand the timeframe over which the ROI occurred. Therefore, we also want to calculate the simple annualized ROI. This value allows us to make fair comparisons between alternative investments. For example, an investment with an RIO of 21% over the course of three years has an annualize ROI value of 7%, while an investment with an ROI of 20% over the course of two years has an annualized ROI value of 10%.
Advantages and Disadvantages of ROI
The biggest advantage of calculating this metric has to do with its simplicity. It is both an often-quoted measure of profitability and it is relatively easy to determine and interpret. Investments with higher ROI values are more desirable than investments with lower ROI values. Or are they?
In this example, business leaders must choose between two projects next year. Project A requires an investment of 1,500,000 and it expected to provide a ROI of 10%, while Project B requires an investment of 2,500,000 and is expected to provide a ROI of 8%. Initially, it seems like the business should choose Project A since its ROI is higher than Project B’s. However, we should also take note of the total gains for each project. Here we find the total gain for Project A is 1,500,000 x 10%, or 150,000, while the gain for Project B is 2,500,000 x 8%, or 200,000. So, while the ROI is higher for Project A, Project B will contribute more to the profits of the business. This example demonstrates the disadvantage of only considering ROI when making an investment decision.