How to determine the return on investment

To assess the economic efficiency of the investments expected when purchasing an existing enterprise or expanding an existing business, many indicators have to be considered. One of these parameters is the payback period of investments, that is, the period of time for which investment costs will be fully reimbursed.

Instruction manual

1

Consider a formula that will help you calculate the return on investment. It includes the payback period, the number of years preceding the payback year, the unreimbursed cost at the beginning of the payback year, the cash inflow for the project payback year:

T = T '+ S / N; Where

T is the payback period of the investment project;

T '- the number of years preceding the payback year;

S - unreimbursed cost at the beginning of the payback year;

N is the amount of cash for the project payback year.

2

Consider, as an example, a method for calculating the payback period using a hypothetical investment project as an example. Suppose this project requires an investment of 10, 000 conventional currency units. As a forecast of income by year, the following sequence of indicators is planned: the first year - 2000 conventional monetary units; second year - 5000 units; third year - 6000 units; fourth year - 8000 units; according to the results of the fifth year, the income will be 9000 conventional monetary units. The discount rate is taken equal to 15 percent.

3

Use a valuation technique based on the timing of the cash flow. If you use the simple statistical method, then in the example considered, the investment would pay off in two and a half years. However, simplified calculations do not take into account the rate of return on investment in a particular area of ​​production. Therefore, you will have to make adjustments to the payback calculation.

4

Calculate the discounted income stream for the investment project in question. At the same time, consider the period when incomes and a discount rate of 15% arise.

5

Calculate what the accumulated cash flow will be. It consists of a simple amount of costs and a stream of income for the project.

6

Calculate the discounted cash flow to a positive value.

7

Using the formula in step 1, calculate the return on investment. You will see that for a real reimbursement of investments under the project, taking into account the time factor, it will take more than three years, that is, significantly more than what is obtained in calculations using a simple statistical calculation method.

Useful advice

Additional source:

"Economic assessment of investments", I.G. Kukukina, T.B. Malkova, 2011.

determine the payback period