ROI and RI

Question 1

ROI formula

Answer 1

ROI = Controllable Profit / Capital Employed x 100
Controllable profit = after depreciation
Capital Employed = non-current assets + current assets - current liabilities

Question 2

RI formula

Answer 2

RI = Income - ( required rate of return x Investement (assets) )

Question 3

Advantages of ROI

Answer 3

• synonymous with accounting rate of return
• used as a common denominator for comparing rates of dissimilar companies
• Competitors, within the group
• Used for years so manager’s understand and consider important

Question 4

Disadvantages of ROI

Answer 4

• may encourage underinvestment (short-term focus)
• disregards strategic alignment to goals
• neglects cost of capital

Question 5

Advantages of RI

Answer 5

• Encourages long-term investments
• Takes into account cost of capital
• Focuses on absolute returns

Question 6

Disadvantages of RI

Answer 6

• Complex to calculate
• Ignores non-financial factors
• Dependence on accurate capital cost

Question 7

What makes ROI seem bad

Answer 7

• New big investments that are yet to see returns
• This demotivates managers