Time Value of Money

Calculations of Returns

Whenever money is invested or in some cases lent, it increases by a certain amount of percentage. This increase in percentage is a result of returns that the lender or the investor is expecting to get on its amount. This amount is called interest rate and the process of calculation is called the calculations of returns.

Since the value of money also is directly proportional to the time it is invested, the returns on the same amount varies. Longer the time that the money is invested, longer will be the returns. All the businesses are into the process of making profits, and for them, it is very important as to what the return of investment on their amounts are. The return of investment determines how much profit their business is making.

Return on Investment

return on investment

Generally, the interest rate determines how much your return on investment will be. Interest is the price that is paid by the borrower for using the lender’s money. In the case of business, a company’s ability to generate sales and make revenues determines the return on investment that they are likely going to make.

When a person borrows money for a certain period then he/she is likely to pay some higher money than he/she borrowed. This excess money is termed as interest levied.

Suppose, you borrowed Rs. 60,000 from someone for a period of 2 years and then you are paying a sum of Rs. 70,000 to that person. Then the difference between initial borrowing and paying is Rs. 10,000 which is the interest you have paid to your lender.

Return on investment is a measurement of the performance that is required to evaluate how good your investment is or to compare the efficiency for different kinds of investments that can be done. It directly calculates the amount of return that you are likely to get on a particular investment in reference to the investment’s cost.

Thus, to calculate ROI, the formula is very simple. It involves the net gain from the investment as compared to the amount you invested.

$$ \text {Return on investment} = \frac{\text{(Gain on the investment – Cost of that investment )}}{\text {Cost of that investment}} $$

The gain from the investment as mentioned above refers to the amount obtained through the sale of the investment of the interest. As you calculate percentage in ROI, it can be easily compared with the other investments that you have made.

Benefits of ROI

ROI is very easy and simple to calculate so it can be used by many people. This also makes the use of ROI very frequent. As the formula does not state any definition of return, it can mean different things to different people. Thus, it only requires two figures to calculate it. The benefit and the cost of your investment.

Further, ROI is universally accepted and so it is assured that everywhere the people will understand how it is calculated and what it means.

Practice Questions on Return on Investment

Q. Boney invested Rs. 1000 in his new business. Two years later he decided to sell his stocks of Rs. 1200. What will be the ROI for Boney?

  1. 10 %
  2. 15 %
  3. 20 %
  4. 25 %

Answer: C. 20 %

Q. Amol started a restaurant with an investment of Rs. 2000 in 2012. He should his shares worth of Rs. 2800, two years later. What will be the ROI for Amol?

  1. 30 %
  2. 32 %
  3. 36 %
  4. 40 %

Answer: D. 40 %

Q. Sunil deposited a sum of Rs. 1,00,000 in the bank for 2 years at a simple rate of interest of 6%. What will be his returns at the end of the interest period?

  1. Rs. 10,000
  2. Rs. 12,000
  3. Rs. 14,000
  4. Rs. 16,000

Answer: B. Rs. 12,000

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