Return on investment and return on equity

Return on investment (ROI) Return on equity (ROE)

Return on investment equals the net income ROE equals to the net income divided by the equity
from a business or a project divided by the total of the investor and multiplying the result by 100.
money invested in the venture multiplied by 100. ROE = Net Income x100
ROI = Net Profit x 100 Equity
Total Capital Invested
Note:
● Total Capital investment include both
Owner’s funds (equity) and borrowed
funds(Debt)
● Net profit can be
Net Profit after tax
Net Profit before interest and tax

Example
You spend ​ `​ 100,000/- to open a grocery shop
and make a net profit of ​`​20,000/- in one year
ROI = (20,000/100,000) x 100 = 20 %
Example
The grocery owner has ​`​ 100,000/- in which an
Owner’s capital (equity) of ​ `​ 40,000/ and borrowed
Capital (Debt) is ​`​ 60,000/- is there. Interest on
borrowed capital is 10% per annum. He made a net
profit of ​`​20,000/- in one year.
The net profit, then would be ​ `​ 14,000/- (= 20,000 –
6,000).
ROE = (14,000 / 40,000) x 100 = 35 %

Formulae to calculate ​Net Profit after tax List of fixed expense

Sales
Less Cost of goods sold
Gross Profit
Less Fixed expenses
Net Profit before tax
Less Tax
Net Profit after tax

Solved question

Q1 Raj Singh has started a restaurant on a National highway in the name of ‘Desi Dhaba’ by spending
Rs.25, 00,000. He invested Rs.10, 00,000 of his own and took a loan of Rs.15, 00,000 from Dena Bank @
6% per annum. His monthly sales revenue is Rs.17, 00,000 and cost of goods sold is Rs.9, 00,000. He pays
monthly salary of Rs.3, 00,000 to his employees. The tax rate is 25%.

You are required to calculate

(a) Return on investment and
(b) Return on Equity for Raj Singh
(Annual Basis)
Equity 10, 00,000
​ Plus​ Debt 15, 00,000
Total Capital Invested 25, 00,000
 Sales Revenue 17, 00,000 X 12 2,04, 00,000
Less​ Cost of goods sold 9, 00,000 X 12 1,08, 00,000
Gross Profit 96,00,000
Less​ Fixed Expenses Salary 3, 00,000 X12 36,00,000
Interest on Loan @ 6% per 90,000
annum 15,00,000 X 6/100
Net Profit before tax 59,10,000
Less ​Tax 59,10,000 X 25/100 14,77,500
Net Profit after tax 44,32,500

ROI = Net Profit / Total Capital Invested x 100

Option 1 Option 2
Net Profit after tax Net Profit before interest and tax
ROI = 44,32,500 /25, 00,000 X100 ROI = 59,10,000 + 90,000 (Interest) /25, 00,000
= 177.3% X100
= 60,00,000/25, 00,000 X100
= 240%

ROE = Net Income/ Equity x100

= 44, 32,500/10, 00,000 × 100

= 443.25%

Unsolved assignment

1. You have newly started a beauty parlour business, you spend `1, 50,000/- to open the
parlour of which you invested `70,000/- of your own money and borrowed a loan for
`80,000/-. Interest rate per annum is 7%. Sales revenue per month is `80,000/-. Cost of
goods sold is `30,000/- per month. Fixed expenses is `30,000/- (salary `20,000/-, rent
and utility `10,000/-), depreciation `3,000/- and tax @ 14%. Please calculate return on
investment and return on equity.

2. You have newly started a restaurant business, you spend `10, 00,000/- to open the
restaurant. You have invested `4, 00,000/- of your own money and borrowed a loan for
`6, 00,000/-. Interest rate per annum is 10%. Monthly sales revenue is `6, 00,000/- and
cost of goods sold is `3, 00,000/-. Fixed expenses per month `2, 00,000/- (salary `1,
50,000/-, rent and utility `50,000/-), depreciation `10,000/- and tax @ 20%. Please
calculate return on investment and return on equity.

3. Karan has started a restaurant on a National highway in the name of ‘ApnaDhaba’ by

spending Rs.20, 00,000. He invested Rs.8, 00,000 of his own and took a loan of Rs.12,
00,000 from SBI @ 6% per annum. His monthly sales revenue is Rs.12, 00,000 and cost
of goods sold is Rs.7, 00,000. He pays monthly salary of Rs.2, 00,000 to his employees.
The tax rate is 25%.You are required to calculate: Return on Investment and Return on
Equity for Karan