Very confusing ROI/return !!!

Question

From finance defition:

ROI =Net Return on Investment/Cost on Investment

or

ROI = (Final Value of Investment − Initial Value of Investment)/ Cost of Investment

Would like to seek clarification on ROI/return is used in different cases and if my understanding is correct -

Case 1:

Kellogg 2018 Tarrant Fixtures

The solution gives a formula of:

ROI = Return/Investment = Profits/Capital Employed = (Revenue - Costs)/(PPE or CAPEX +Working Capital)

I think the formula is wrong, as Profits is NOT Return. Unless, in the calculation, initial CAPEX is amortised to yearly costs to come up with the Net Profit.

(For this case, they assume no new investment, so using Profit alone as Return is ok, however, the formula given is VERY misleading.)

Case 2:

Darden 2018-29 Fire Proof

“The company wants to achieve at least a 15% ROI on any new expansion project within 3 years. The company will need to invest $100M in capital expenditures."

Calculation given in the case solution:

Total net profit over 3 years = $16.5M + $36.3M + $60M = $112.8M
ROI = ($113M –100M) / $100M = 13%

So they are treating (Total Net Profits - Total Investment) = Net Gain, and use ROI = Net Gain/Total Investment

If the interviewee misuses Net Profit as Net Gain, it's wrong.

Case 3:

Stern 2019 Bike Helmet

“ The PE firm holds companies for an average of 7 years and has a return target of 10%/year.”

Does it mean: the total return over 7 years holding period need to be 70%. The total return = (Dividends + Capital Gain) /Investment = (Dividends + Price sold at exit - Acquisition Costs)/Acquisition Costs ?

***Though actually,

Annualized ROI=[(1+ROI)1/n−1]×100% where:n= Number of years for which the investment is held; I explained the above in a simplified way ***

Answer 1

Hi there,

You do realize these 2 formulas are the exact same, right?

"ROI =Net Return on Investment/Cost on Investment

or

ROI = (Final Value of Investment − Initial Value of Investment)/ Cost of Investment"

Net Return on Investment literally equals final value minus initial value!

All that's difference is what you're provided in the case.

This is kind of like saying there are conflicting breakeven formulas just because one has you solve for price and the other has you solve for # of years for payback!

Answer 2

Hi there,

Of course you know that these are only practice cases and the answers doesn't actually matter. What you need to take away from them is that you know how to calculate what the interviewer is asking for.

In a real interview (same goes for real client situation), you just need to clarify what the interviewer is asking for, regardless of whether you think you understand the term (also, believe it or not, the interviewer can be mistaken, too, so always clarify). Then, you align on your approach with the interviewer. You can state your assumption, whether or not you believe up-front investment needs to be included and have the interviewer comment.

I think the take-away here is that the case interviewer is not like a test where you need to memorize formulas and terms. Don't use that approach when practicing. You've demonstrated sufficient understanding of these concepts, now move on!

Hope that helps,

Allen