Return on investment index. Return on investment index

The purpose of the investment is to generate income from capital. The economic benefit is assessed not only in absolute terms, but also in terms of relative indicators. In particular, the costs that had to be incurred in order to achieve the result. Investors are primarily interested in investments in which each ruble will bring maximum profit. To calculate such data, a special indicator is used - the return on investment index.

Project evaluation

The principle of determining the effectiveness is to compare the analyzed indicator with the base value. In terms of investments, these are a bank deposit and a discount rate. Investments are considered profitable, the income of which exceeds the profit from the deposit.

The following indicators are used to analyze projects:

• net investment value (NPV);
• internal profitability (IRR);
• return on investment index (PI);
• payback (PP).

Let's consider each of them in more detail.

Net Present Value (NPV)

This indicator is calculated as the difference between the investment and the current cost of payments. NPV excludes the time factor. If the value of the current cost> 0 - the project is profitable; equals 0 - an increase in volumes will not contribute to an increase in profits;< 0 – проект убыточен.

NPV is an absolute indicator. Its value is strongly influenced by the initial investment and the cost distribution structure. The more costs will be in subsequent periods, the greater the amount of net present value will be. Therefore, a high value of the indicator does not always mean a more efficient investment of funds. Calculation formula:

NPV = ∑ - IC, where:

• FV - discounted cash flow;
• IC - initial investment;
• t - year;
• r is the discount rate.

NPV calculation example

For convenience and clarity, we have placed all the necessary numbers in the table.

Receipts	Investments	Discount rate
0	279	0,91
0	186	0,83
186	0	0,75
279	0	0,68
372	0	0,62

We will calculate the current cost of the project

1. Discounted income:

PV = 186 x 0.75 + 279 x 0.69 + 372 x 0.62 = 561.3 thousand rubles.

2. Discounted investment amount:

PV = 279 x 0.91 + 186 x 0.83 = 407.3 thousand rubles.

3. Net investment value:

NPV = 561.3 - 407.3 = 154 thousand rubles.

The key point in calculating NPV is the choice of discount rate. In this process, it is necessary to take into account the size of risk-free (bank) rates, the rate of costs, uncertainty, the risk of long-term investments, etc.

Discounting cash flows reflects a project that generates more revenue. But the “best” investment may be a risk-free one.

Rate of return (IRR)

This ratio characterizes the maximum cost of investments (expenses) that can be incurred within the framework of this project. If financing is carried out at the expense of a bank loan, then the IRR value shows the upper limit of the service rate. If it is exceeded, the project will be unprofitable. Economic sense: the company can make decisions, the profitability of which exceeds the current price of funds - SS:

• rate of return> CC - the project is profitable;
• rate of return< СС – проект убыточен, его следует отклонить;
• rate of return = CC - the project is break-even, but will not bring profit.

PI

The ratio of profit to the amount of invested capital, the discounted value of earnings per unit of investment, reflects the return on investment index. Formula for calculation:

PI = 1 + NPV: I, where I - attachments.

The indicator "investment return index" is relative. It displays the ratio of net cash flow to costs. Due to this advantage, the indicator can be used for comparative evaluation of projects that differ in the amount of initial investment. Also, the return on investment index should be used to identify and exclude ineffective projects at the stage of consideration. The following solutions are possible:

• If the return on investment index (PI)> 1.0 - investments will bring profit, provided that the selected rate is used.
• PI< 1,0 – инвестиции не окупятся.
• PI = 1.0 - the return rate is equal to the IRR.

Projects with a high return on investment index are more sustainable. But do not forget that large values ​​of the coefficients do not always correspond to the level of net present value, and vice versa.

Example

Using the return on investment index, we calculate the efficiency of two projects. For greater clarity, we use the table again.

Year	Project A		Project B		Discount coefficient
	Receipts	Investments	Receipts	Investments
1	0	500	0	780	0,83
2	270	0	345	0	0,75
3	330	0	525	0	0,68
4	375	0	600	0	0,62
TOTAL	975	500	1470	780

Let's find the net cash flow for both projects:

NPV 1 = 270 x 0.75 + 330 x 0.68 + 375 x 0.62 - 500 x 0.83 = 244.4 thousand rubles.

NPV 2 = 345 x 0.75 + 525 x 0.68 + 600 x 0.62 - 780 x 0.83 = 340.4 thousand rubles.

Let's calculate the return on investment index. Formula:

PI = 1 + NPV: I.

Obviously PI depends on NPV. If the net cash flow is negative, then the project will not bring profit. If NPV> 0, then a project with a higher indicator value will be considered more profitable:

PI 1 = 1 + 244.4 / 500 = 1 + 0.49 = 1.49.

PI 2 = 1 + 340.4 / 780 = 1 + 0.44 = 1.44.

Price change rate

ROC shows how the price has changed at the moment compared to the n-th period in the past. It can be presented in points or percentages.

Discounted investment profitability index

In the case of a one-time investment of capital in a project, a discounted index is calculated:

DPI = PV / IC, where:

• PV is the present value of receipts;
• IC - the amount of the initial investment.

If the investment process is divided into several stages, then the indicator will be calculated using a different formula:

DPI = PV k: (IC k: (1 + r) k), where:

• PV k - present value of receipts for the period k;
• IC k - amount of investment;
• r - bid.

If DPI value < 1.0, then the project should not be accepted, as it will not bring additional income.

Payback (PP)

The period during which funds are received in an amount that compensates for the initial investment is called the payback period. It is measured in months and years. Payback comes when NPV becomes positive.

The calculation algorithm depends on the uniformity of income distribution. If the size of the expected profit is normally distributed, then the PP is calculated according to the following formula:

The PP should be less than the maximum acceptable period.

If the amount of income differs by year, then the PP is determined by calculating the number of years for which the income will be equal to the amount of the initial investment.

Period	Cash flow, thousand rubles
0	- 25	-25
1	20	-25 + 20 = -5
2	25	-5 + 25 = 20
3	30	20 + 30 = 50

PP = 1 + 5: 25 = 1.2 years.

The PP calculated according to this formula does not take into account the time factor. This disadvantage eliminates the discounted payback period (DPB) - the length of time it takes to recover the investment from the present value of the proceeds. It is calculated by dividing the cost by NPV, given to date. When analyzing projects using PP and DPP, the following conditions are true:

a) the project is accepted if it pays off;

b) if the calculated period is less than the maximum allowable, which the company considers acceptable, then the project is accepted;

c) of a number of options, the acceptable one is the one with a shorter payback period.

DPP and РР allow to obtain approximate estimates of liquidity and riskiness.

Period	Cash flow, thousand rubles	Accumulated cash flow, thousand rubles
0	- 30	-30
1	17, 86	-30 + 17,86 = -32,14
2	19, 925	-32.14 + 19,925 = 12,215
3	21, 36	-12,215 + 21,36 = 9,145

DPP = 1 + 12215/21360 = 1 + 1.57 = 2.57 years.

PP displays the number of years during which the initial investment will pay off. But the investor hopes not only to return the funds, but also to make a profit. Economic profitability is determined for the period of time following the payback. If the duration of the project corresponds to the RR, then the investor will incur a loss in the form of lost profit from other areas of investment.

DPP and PP have their own pros and cons. They cannot be considered as the only selection criterion.

How to calculate profitability

Based on the above indicators, a decision is made to invest in the project. In this case, the following algorithm is used:

1. NPV is calculated, the period for which this value will exceed zero is determined.
2. The internal rate of return is compared to the prevailing deposit rates. If the IRR is higher than the income level guaranteed by the bank, the investment is advisable.
3. The calculation of the return on investment index is carried out. Investments are advisable if the value of the indicator exceeds 1.
4. The most profitable project is selected from several options.