1

Calculation of Return on Investments

Farrokh Alemi, Ph.D.

2

Present Value

YR) (1

Cash Future ValuePresent

3

“Show Me the Cash”

YR) (1

Cash Future ValuePresent

Inter

est r

ate

or op

portu

nity c

ost

of in

vestm

ent

Years

before

receiv

in

g the

cash

4

Example of Present Value

747.06) (1

$1,000 ValuePresent

5

If we assume a 6% interest rate, receiving $1,000 in 5 Years is worth $747 today.

Interest rate Years till return

5

Calculation of Return on Investment

%100sInvestment of ValuePersent

ReturnsYear Future of ValuePresent

ROI

Years

Years

6

Calculation of Return on Investment in 3 Steps

1. Calculate present value of future returns

7

Calculation of Return on Investment in 3 Steps

1. Calculate present value of future returns2. Calculate present value of investments

8

Calculation of Return on Investment in 3 Steps

1. Calculate present value of future returns2. Calculate present value of investments3. Take the ratio

%100sInvestment of ValuePersent

ReturnsYear Future of ValuePresent

ROI

Years

Years

9

Example Step 1: Present Value of IT Costs

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value? $83,176 $63,188 $39,743 $28,120 $21,221

Assume 6% Interest Rate or 0.06

10

Example Step 1: Present Value of IT Costs

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value? $83,176 $63,188 $39,743 $28,120 $21,221

$0

$25,000$50,000

$75,000

$100,000$125,000

$150,000

$175,000

$200,000$225,000

$250,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Shows returnsin each year

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Example Step 1: Present Value of IT Costs

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value $83,176 $63,188 $39,743 $28,120 $21,221

$0

$25,000$50,000

$75,000

$100,000$125,000

$150,000

$175,000

$200,000$225,000

$250,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t 1.06) (1

$88,167 1Year ValuePresent

12$0

$25,000$50,000

$75,000

$100,000$125,000

$150,000

$175,000

$200,000$225,000

$250,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 1: Present Value of IT Costs

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value $83,176 $63,188 $39,743 $28,120 $21,221

13$0

$25,000$50,000

$75,000

$100,000$125,000

$150,000

$175,000

$200,000$225,000

$250,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 1: Present Value of IT Costs

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value $83,176 $63,188 $39,743 $28,120 $21,221

2.06) (1

$70,999 2Year ValuePresent

14$0

$25,000$50,000

$75,000

$100,000$125,000

$150,000

$175,000

$200,000$225,000

$250,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 1: Present Value of IT Costs

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value $83,176 $63,188 $39,743 $28,120 $21,221

15$0

$25,000$50,000

$75,000

$100,000$125,000

$150,000

$175,000

$200,000$225,000

$250,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 1: Present Value of IT Costs

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value $83,176 $63,188 $39,743 $28,120 $21,221

16$0

$25,000$50,000

$75,000

$100,000$125,000

$150,000

$175,000

$200,000$225,000

$250,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 1: Present Value of IT Costs

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value $83,176 $63,188 $39,743 $28,120 $21,221

17$0

$25,000$50,000

$75,000

$100,000$125,000

$150,000

$175,000

$200,000$225,000

$250,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 1: Present Value of IT Costs

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value $83,176 $63,188 $39,743 $28,120 $21,221

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Example Step 1: Present Value of IT Costs

Present Value of 5-year Cost of Investment$235,450,000

  Year 1 Year 2 Year 3 Year 4 Year 5

Cost in 000 $88,167 $70,999 $47,335 $35,501 $28,399

Present value $83,176 $63,188 $39,743 $28,120 $21,221

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Example Step 2: Present Value of Future Revenues

Year 1 Year 2 Year 3 Year 4 Year 5 Total

$333,304,921 $333,322,089 $333,345,753 $333,357,587 $333,364,689 1,666,695,037

$0

$200,000,000

$400,000,000

$600,000,000

$800,000,000

$1,000,000,000

$1,200,000,000

$1,400,000,000

$1,600,000,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Shows future returns

20

Example Step 2: Present Value of Future Revenues

Year 1 Year 2 Year 3 Year 4 Year 5 Total

$333,304,921 $333,322,089 $333,345,753 $333,357,587 $333,364,689 1,666,695,037

$0

$200,000,000

$400,000,000

$600,000,000

$800,000,000

$1,000,000,000

$1,200,000,000

$1,400,000,000

$1,600,000,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

1.06) (1

21$333,304,9 1Year ValuePresent

21

$0

$200,000,000

$400,000,000

$600,000,000

$800,000,000

$1,000,000,000

$1,200,000,000

$1,400,000,000

$1,600,000,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 2: Present Value of Future Revenues

Year 1 Year 2 Year 3 Year 4 Year 5 Total

$333,304,921 $333,322,089 $333,345,753 $333,357,587 $333,364,689 1,666,695,037

314,438,604

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$0

$200,000,000

$400,000,000

$600,000,000

$800,000,000

$1,000,000,000

$1,200,000,000

$1,400,000,000

$1,600,000,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 2: Present Value of Future Revenues

Year 1 Year 2 Year 3 Year 4 Year 5 Total

$333,304,921 $333,322,089 $333,345,753 $333,357,587 $333,364,689 1,666,695,037

314,438,604

2.06) (1

89$333,322,0 2Year ValuePresent

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$0

$200,000,000

$400,000,000

$600,000,000

$800,000,000

$1,000,000,000

$1,200,000,000

$1,400,000,000

$1,600,000,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 2: Present Value of Future Revenues

Year 1 Year 2 Year 3 Year 4 Year 5 Total

$333,304,921 $333,322,089 $333,345,753 $333,357,587 $333,364,689 1,666,695,037

314,438,604 296,655,472

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$0

$200,000,000

$400,000,000

$600,000,000

$800,000,000

$1,000,000,000

$1,200,000,000

$1,400,000,000

$1,600,000,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

os

t

Example Step 2: Present Value of Future Revenues

Year 1 Year 2 Year 3 Year 4 Year 5 Total

$333,304,921 $333,322,089 $333,345,753 $333,357,587 $333,364,689 1,666,695,037

314,438,604 296,655,472 279,883,522

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$0

$200,000,000

$400,000,000

$600,000,000

$800,000,000

$1,000,000,000

$1,200,000,000

$1,400,000,000

$1,600,000,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

IT C

ost

Example Step 2: Present Value of Future Revenues

Year 1 Year 2 Year 3 Year 4 Year 5 Total

$333,304,921 $333,322,089 $333,345,753 $333,357,587 $333,364,689 1,666,695,037

314,438,604 296,655,472 279,883,522 264,050,432

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Example Step 2: Present Value of Future Revenues

Year 1 Year 2 Year 3 Year 4 Year 5 Total

$333,304,921 $333,322,089 $333,345,753 $333,357,587 $333,364,689 1,666,695,037

314,438,604 296,655,472 279,883,522 264,050,432 249,109,488 1,404,137,518

Present Value of 5-Year Future Revenues =$1,404,137,518

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Example Step 3: Return on Investment

Years

Years

sInvestment of ValuePersent

ReturnsYear Future of ValuePresent

ROI

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Example Step 3: Return on Investment

Years

Years

sInvestment of ValuePersent

ReturnsYear Future of ValuePresent

ROI

%596%10000$235,450,0

5181,404,137, ROI

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Take Home Lesson

Calculate ROI in 3 easy steps as the ratio of present value of returns over present value of investment