# Return on Investment - Posted by Brandt Frederick

Posted by DanM(OR) on December 20, 1999 at 16:37:29:

meant to say.

Great job explaining it Sean. I was in a hurry this morning when I posted.

Best of luck to you!

Dan Matejsek

Return on Investment - Posted by Brandt Frederick

Posted by Brandt Frederick on December 18, 1999 at 06:25:07:

I have a question concerning the calculation of return on investment. If I invest \$ 11,000. today and four (4) months from today receive back my original \$ 11,000. plus a profit of \$ 4,000., how would I calculate my return on investment as a percentage? In this example, what would my % return be?

ROI vs. Yield - John Behle can you explain? - Posted by Jim-WI

Posted by Jim-WI on December 20, 1999 at 09:40:25:

I guess we should clarify the difference between ROI and yield. I personally am not qualified to do this as I have often asked myself this question.

The way I figure ROI is take profit/investment. In this case ROI = 36.4%. It would be like investing in stocksâ€¦ in 4 months it increased 36.4% (ROI if I cashed out).

Since I donâ€™t know what investment vehicle is talked about (i.e. a note or home) it is difficult to say if we should talk about Yield (for notes) or ROI. It seems everyone has been talking about yield since this is the cashflow forum. But is it really what Brandt is asking for? A 100% ROI would tell me he doubled his money which isnâ€™t the case.

John perhaps you could help shed some light on the ROI vs. Yield issue? Thanks!

Re: Return on Investment - Posted by Sean

Posted by Sean on December 18, 1999 at 22:17:23:

Using my calculator you type in:
11000 [PV] (how much invested)
15000 [FV] (how much returned)
4 [n] (how many months)
0 [PMT] (no monthly payments will be made)
[CPT] [i%]
8.06% (that is monthly)
x12 = 96.75% annual return.

Re: ROI vs. Yield - John Behle can you explain? - Posted by John Behle

Posted by John Behle on December 21, 1999 at 15:13:08:

In notes what you look at is the â€śIRRâ€ť or yield. The IRR or â€śInternal Rate of Returnâ€ť takes into account the compounding period. That is where people come up with different answers.

It is all about how the note is worded. A note can be compounded over almost any period and it can make a large difference.

If I loan or invest \$10,000 and charge 10% â€śsimple interestâ€ť over 5 years, then the payoff would be \$15,000. That equals 10% of \$10,000 or \$1,000 each year.

If that is written as 10% annual interest, then the compounding period is each year. The first year there is interest of \$1000. The second year there is the same \$1000 PLUS interest on the previous yearâ€™s interest. Over 5 years that totals to a payoff of \$16,105.10 - a difference of \$1105.10 over the â€śsimpleâ€ť interest.

Most people try to calculate a monthly compounding on everything - even if they do not have the right based on how the note is written. A monthly compounding results in a much higher figure.

The monthly compounding adds interest each month and then calculates the next monthâ€™s interest on the new balance that includes the previous monthâ€™s interest.

Which do you calculate? It all depends how the note is worded. It isnâ€™t your option. When it comes to discounting, you have the same type of decisions. There is an article that explains more about that at www.papergame.com titled â€śClearing the Calculator Confusionâ€ť.

Came up with 109%, what did I do wrong? - Posted by Ben

Posted by Ben on December 19, 1999 at 18:42:21:

I did this without a financial calculator merely by
annualizing the profit (\$4,000 every four months equals
\$12,000 annualized) then I divided \$12,000 by the \$11,000 original investment to come up with 109%. Seems simple but apparently I am missing something, what is it?

Effective vs. nominal rate - Posted by Sean

Posted by Sean on December 20, 1999 at 11:35:51:

Letâ€™s suppose we were to draw up an agreement that you were going to borrow \$1,000 from me and I would charge you 18% interest and it would compound monthly (1.50% interest per month). You would make no payments at all for a year then the entire amount would come due.

The day the money is due you show up with \$1,000 plus \$180 representing (in your mind) 18% interest on 1000 dollars. What a shock when I tell you that the amount of the payoff is \$1,195.62.

â€śImpossible,â€ť you think to yourself. â€śWe agreed to 18% interest not 19.562 percent.â€ť

Well, the reason itâ€™s more is because we considered that some of that interest showed up every month and there was interest on interest. We call this compound interest. The annual effective rate of the loan was 19.562% and the nominal rate was 18 percent.

When I said 96.75% I was giving a nominal rate based on a 12-month investment. Perhaps thatâ€™s not the best way to look at it, but rather we should look at the annual effective rate.

If you invested \$11,000.00 now and got \$15,000.00 in four months and if you re-invested that \$15,000 you should get \$20,454.55 and if you re-invested that you should get \$27,892.57

In other words, your effective annual rate would be 27,892.57 / 11000 or 253.57 percent. Similarly if you loaned someone \$11,000 at 96.75% interest (8.06% monthly) and they made no payments for a year youâ€™d get \$27,892.84 at the end of the year for approximately the same, effective annual rate.

In other words a 109% investment compounded every 4 months, a 96.75% investment compounding monthly, a simple interest rate of 254% and a 93.17% interest compounding daily are, essentially, the same animal. They all have an effective annual rate of approximately 254%

And the answer is?? Youâ€™re both right! (nt) - Posted by DanM(OR)

Posted by DanM(OR) on December 20, 1999 at 10:45:18:

.