Two Ways to Compute ROI

In finance, the term "return on investment" formula, usually called ROI or return, is a method used in calculating whether a potential investment is wise. Meaning, the results of an ROI calculation could give an estimate whether the investment could repay the investor. The ROI is calculated as the ratio of the amount lost (negative ROI) or amount gained (positive ROI) relative to the basis.

There are two ways to calculate basic ROI, each having its own mathematical values.

1) Arithmetic Returns - This type of ROI is (Vf - Vb) / Vb, where Vf is the final value and Vb is the basis. This type of return is characterized by an investment that is doubled or profitable and or an investment that is at a loss or can no longer be recovered.

2) Logarithmic Returns - This type of ROI is calculated as the value minus the value at time of purchase, divided by the value at time of purchase. The problem with this type of computation is that a positive 10% return and a negative 10% return do not add up to 0%. However, finance experts usually use this type of method.

Academics often use logarithmic returns in their research because the continuously compounded return is symmetric, where as the arithmetic return isn't. Negative and Positive % arithmetic returns are not equal for example:

An arithmetic return of 50% on $100 followed by a negative 50%, is $75.

A logarithmic return using the same calculations, returns $100.

Both ways to compute ROI can be used in different types of investments and in various scenarios. However, the results should only be used as a general guide.

[expert=Viv_Smitheram]

Enter Your Email Address For Update :

FeedBurner

Related Post :