Return on investment, or ROI, analysis is one of the most commonly used financial methods for evaluating the financial outcomes of business investments. ROI is defined to divide net operating income by average operating assets:
ROI=(Net operating income)/(Average operating assets)
The higher the return on investment ratio, the greater the profit gained per dollar invested in the operating assets. In the equation, net operating income is earnings before interest and taxes, or EBIT. The reason why net operating income is used in the formula instead of EBIT is because the denominator consists of average operating assets. Operating assets consist of both current assets and long-term assets, including—cash, accounts receivable, inventories, plants and equipment, and other assets that relevant to operation. The average operating assets base in the formula is usually calculated as the average between the operating assets at the beginning of the year and those at the end of the year. Most organizations are using the net book value approach to compute average operating assets, which uses acquisition minus accumulated depreciation. However, this approach has flaws. The net book value decreases over time while the accumulated depreciation increases. Consequently, the decreasing denominator of ROI increases ROI in the calculation. As a result, ROI will continuously increase over time until to the point of replacing the old equipment with a new one. On the contrast, new equipment increases the book value of the assets, increases the denominator of the formula and therefore decreases ROI. Thus, this net book value approach used in the calculation results in a constant gross of ROI over time as accumulated depreciation increases and therefore discourages companies replacing old equipment with a new one. Nevertheless, companies still use this approach to calculate ROI because it