The return on capital employed is used as a criterion for making investment decisions. Net capital employed, consisting of total assets minus current liabilities, is used to calculate the return Net profit is used as return.
- Satisfactory return is influenced by the nature of business, risks involved, comparative return from fixed deposit in Banks, and external economic conditions.
- If the ROI is satisfactory, the project is accepted.
Advantages of ROI
- It is simple to calculate, operate and understand.
- It considers the cash flow throughout the life of the project.
- It serves as a standard to compare profitability of alternative projects.
Disadvantages of ROI
- It ignores time value of money.
- It is difficult to define what is satisfactory rate of return.
- It ignores varying profit from various projects.
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