The rate of return is always expressed as a percentage and is calculated using the following formula:
ROR = (Net Income / Investment Cost) x 100
Net Income = Gain on Investment - Investment Cost
For instance, if the investment cost is $40,000 and the gain is $42,000, then the net income is $42,000 - $40,000, or $2,000. This gives an ROR of ($2,000/$40,000) x 100, which is equal to 0.05 x 100, or 5%. A higher ROR indicates better returns.A negative ROR indicates losses.
The rate of return is indicative of only the profitability and not the size or duration of an investment. ROR also does not take into account inflation. However, the two should be compared. If the rate of return is lower than the annualinflation rate, there will be erosion in value.
The rate of return is a concept used for various purposes, such as: