Virginia Contractor General Practice Test

What is the formula for return on investment?

1. Net Income / Total Equity

2. Net Income / Total Revenue

3. Net Income / Total Assets

4. Net Income / Total Liabilities

The correct answer is: Net Income / Total Assets

The formula for return on investment (ROI) is commonly understood as a measure of the profitability of an investment relative to its cost. It essentially evaluates the efficiency or quality of an investment. The correct formula, which is represented by the option selected, involves dividing the net income generated from the investment by the total assets used in that investment. This approach allows investors or business owners to see how much profit they are earning from the assets employed in generating that income. By focusing on total assets, this measure reflects the overall effectiveness of the investment in generating income relative to the resources and capital tied up in those assets. In contrast, the other formulas would not accurately capture the essence of ROI: - Dividing net income by total equity focuses solely on the owner's equity stake in the business, which does not represent the total financial performance relative to all invested resources. - Using total revenue in the denominator compares income to sales but ignores the important relationship with costs and assets needed to generate that income. - Lastly, dividing by total liabilities would provide a measure of return relative to what is owed, rather than what has been invested in generating profits. Therefore, the correct formula for ROI provided reflects a comprehensive approach to understanding investment performance in relation to the total resources utilized.