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1. Return on Investment (ROI) Valuation
ROI valuation method is primarily used to understand the profitability of an investment relative to its cost. When applied to business valuation, it calculates the time it will take for an investor to recoup the investment based on projected returns. Higher ROI values typically indicate better investments. An ROI-based valuation sets the price of the business such that an investor can achieve a targeted ROI.
The ‘Return on Investment Valuation’ method, at its core, tries to evaluate the profitability of an investment by comparing the expected returns to the total cash outlay (which would include the initial investment, additional expenditure, amount of debt, and other cash invested).
The table below provides an explanation and an example for each of the input variables related to the ‘Return on Investment (ROI) Valuation’ method:
| Input Variable | Explanation | Example |
| Additional Expenditure | This refers to extra costs or expenses that will be incurred due to the investment but are not part of the initial investment itself. These could be operational, maintenance, or any unforeseen expenses. | A company wants to buy a new machine for £50,000. Training staff to use this machine costs another £5,000. The additional expenditure is £5,000. |
| Amount of Debt | This indicates how much borrowed capital is being used for the investment. It can impact ROI because debt typically carries interest, which would affect the net returns of the investment. | A business acquires a new property worth £300,000 but uses a bank loan of £200,000 to finance the purchase. The amount of debt is £200,000. |
| Assume ROI | This is the expected or target return on the investment. It serves as a benchmark or goal for the investor. | An investor wants a 10% return on a stock market investment. The assumed ROI is 10%. |
| Other Cash Invested | This refers to any additional cash or capital infused into the investment, which is not part of the primary investment or the additional expenditure. It might include reserve funds, contingency funds, or any other supplementary cash injections. | For the same machine purchase of £50,000, if the company sets aside another £10,000 for potential repairs or upgrades, then the other cash invested is £10,000. |
