Question 13.2: An investment of €300,000 generates cash inflows of €150,000...
An investment of €300,000 generates cash inflows of €150,000 during each of the next three years. The investment is fully depreciated using the straight-line method over the three years. There are no other accrual effects, so the annual net income of the investment is €150,000 – €100,000, or €50,000. The average investment is used as the denominator to calculate the ROI. What is the ROI for each year and what is the multi year ROI? How would the sum of the years’ digits method of depreciation affect the calculation of ROI?
Using the straight-line depreciation method:
| Year | Profit | Average Investment | ROI |
| 1 | € 50,001 | € 250,000 | 20% |
| 2 | 50,000 | 150,000 | 33 |
| 3 | 50,000 | 50,000 | 100 |
The multi-year ROI is €50,000/€150,000, or 33 percent.
The sum of the years’ digits method results in depreciation of €150,000 in the first year, €100,000 in the second year, and €50,000 in the third. Therefore, the ROI for each year is as follows:
| Year | Profit | Average Investment | ROI |
| 1 | € 0 | € 225,000 | 0% |
| 2 | 50,000 | 100,000 | 50 |
| 3 | 100,000 | 25,000 | 400 |
The average annual profit is €50,000, but the average investment over the three years is €100,000, so the multi-year ROI is €50,000/€100,000, or 50 percent. Note that accounting methods affect the ROI, making it less desirable.