This article accompanies our feature "Money's tight? ROI to the rescue." Please click through to that article for details on how ROI measurements have taken on new meanings and importance for IT projects.
Return on Investment (ROI)
ROI (annual return divided by initial investment) has been a favorite metric for years. It is easy to compute and easy to understand. But it can be dangerously misleading.
Consider these traps:
1. Which is a better investment: Project A, which has an ROI of 10%, or Project B, which has an ROI of 15%? Project B, right? But what if ...
| Project A | Project B | |
| ROI | 10% |
15% |
| Investment amount | $1 million |
$1,000 |
| Annual return | $100,000 |
$150 |
2. What is the annual ROI from Project C, where $1 million is invested?
| Year 1 return | $0 |
| Year 2 return | $100,000 |
| Year 3 and subsequent year returns | $250,000 |
Is there a temptation to cook the numbers here, to claim $250,000 instead of an average as the annual return?
3. Which of these projects has a "better" ROI? Which would you fund?
| Project D | Project E | |
| Year 1 ROI | 15% |
5% |
| Year 2 ROI | 10% |
10% |
| Year 3 ROI | 5% |
15% |
| Year 4+ ROI | 0% |
20% |
Does it depend on your confidence in long-range predictions?
4. Is a project with a guaranteed ROI of 10% a good investment? What if your company's cost of capital is 15%?
Return to Money's tight? ROI to the rescue.