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In: Accounting

How do you evaluate an operating segment or project using return on investment?

How do you evaluate an operating segment or project using return on investment?

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Expert Solution

Operating segment using return on investment:- Operating segment performance may be evaluated using either Return on Investment or Residual Income. ROI measures the segments ability to utilize its operating assets to generate income.

  • ROI measures the segments ability to utilize its operating assets to generate income. ROI focuses on how efficiently the assets are used since it expressed as a percent of the assets used. The ability to generate income by utilizing operating assets varies widely by industry and by company within an industry.
  • Return on Investment (ROI) has three interrelated formulas: ROI = Net operating income Average operating assets ROI = Margin X Turnover ROI = Net operating income X Sales Sales Average operating assets
  • Margin = Net Operating Income / Sales or the ability to keep a portion of sales dollars in the business as income.
  • Turnover = Sales / Average Operating Assets or the ability to use operating assets to generate sales.

Operating project using return on investment:- An indicator used to measure the financial savings/gain (or loss) of a project in relation to its cost. Typically, it is used in determining whether a project will yield positive financial benefits, and in turn giving approval to proceed.

Project ROI = ((project’s financial gain or loss – project’s cost) / project’s cost) X 100.

In the above formula, "Gain from Investment” refers to the proceeds obtained from the sale of the investment of interest. Because ROI is measured as a percentage, it can be easily compared with returns from other investments, allowing one to measure a variety of types of investments against one another.


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