Return on Investment is a little confusing. Sometimes it is used to mean a specific financial measurement while other times it is used as a collective term to refer to ROI and the other traditional financial measures such as Payback, Internal Rate of Return (IRR), and Net Present Value (NPV). However, as a measure in its own right ROI is expressed as a percentage over a specific period of time. Therefore a typical ROI may be 45% over 3 years.
The pluses of ROI include:
- It specifies a particular time period
- It takes into account the time value of money
It is simple to calculate ROI but it has one deficiency: It does not tell you anything about the magnitude of the project. The formula for ROI is simply
(net benefit year 1 / (1+discount rate) + net benefit year 2 / (1+discount rate) + net benefit year 3 / (1+discount rate)) / initial cost