Question

Explain how ROI works and how it would impact the purchase of new equipment.

Summarize why new equipment would be beneficial to the organization. Why or why not?

Answer 1

Return on investment is the return i.e. the net income divided by the investment made by the company. Investment here is to imply the total capital employed in the assets of the business. The investment simply put is the total assets less the non interest bearing current liabilities. ROI works on the inputs in the numerator and denominator. If the denominator is low i.e. the total assets are lesser then the ROI is higher and vice versa. If the net income tends to rise and the investment level remains as is then the ROI is higher. However, if the investment level increases but the net income tends to remain same then the ROI reduces. If a new equipment is purchased the ROI decreases in the short run since the investment level increases but the income level remains the same in the short term since the asset will not start yielding monetary benefits immediately. However, in the long run the ROI will increase due to equipment as the investment level reduces due to depreciation of the asset and the net income increases as the asset tends to generate revenues. The new equipment may initially tend to pull down the ROI for the business as explained earlier but for the long term success of the company an investment in new equipment is certainly worth it.