## What is ROI?

The **Return on Investment (ROI)** is a profitability ratio that compares the net profits received at exit to the original cost of an investment, expressed as a percentage.

- ROI stands for “Return on Investment” and measures the profitability of an investment relative to its cost.
- ROI is a method for businesses and investors to determine the efficiency and effectiveness of their capital allocation and investment strategy.
- The ROI formula is the ratio between the net profit earned on an investment and the cost of the investment, expressed as a percentage.
- The ROI ratio is a practical tool for investors because the metric can guide informed financial decisions, such as for tracking the performance of existing investments, or to evaluate the potential return of an investment.

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## How to Calculate Return on Investment (ROI)

The ROI—or “Return on Investment—is the ratio between the net return and the cost of an investment.

The return on investment (ROI) formula is straightforward, as the calculation simply involves dividing the net return on the investment by the investment’s corresponding cost.

**Net Return**→ Total Profits Received**Cost of the Investment**→ Total Amount Spent

In practice, the ROI is not only used by individual and institutional investors to track their portfolio, but also by corporations that rely on the metric for internal purposes, such as their decision-making processes regarding which projects to pursue and for decisions on optimizing how to allocate their capital on hand.

**Therefore, the ROI is a method for investors to determine the efficiency of their current capital allocation strategy, including the effectiveness of past investments.**

The higher the return on investment (ROI) on a project or investment, the greater the monetary benefits received — all else being equal.

However, what constitutes whether the ROI is adequate differs based on the target return specific to the investor and the length of the holding period, among other factors.

## ROI Formula

The formula for calculating the return on investment (ROI) is as follows.

**Return on Investment (ROI) =**(Gross Return

**–**Cost of Investment)

**÷**Cost of Investment

Where:

- Net Return = Gross Return – Cost of Investment

The difference between the gross return and the cost of investment is the net return.

**Return on Investment (ROI) =**Net Return

**÷**Cost of Investment

For purposes of comparability, the return on investment metric is typically expressed in percentage form, so the resulting value from the above formula must then be multiplied by 100.

The numerator in the formula, the return, represents the “net” return — meaning that the cost of the investment must be subtracted from either:

- Gross Returns (or)
- Total Exit Proceeds

## Expected ROI Calculation Example

For example, suppose a hedge fund is considering an investment, where the expected gross return is $100k while the total cost incurred is $80k.

The net return on the investment is anticipated to be $20k.

- Gross Return = $100k
- Initial Cost = $80k
- Net Return = $20k

With that said, the return on investment (ROI) ratio can be calculated by dividing the $20k net return by the cost of $80k, which comes out to 25%.

- Expected Return on Investment (ROI) = $20k ÷ $80k = 0.25, or 25%