Glad to meet you again! Would you please remind: ROI?
(RETURN ON INVESTMENT)
This time around, ROI will be shreded, so thus risk as a third element can be added as a matter of capital account. The original formula states: ROI = (NET INCOME-NET INVESTMENT) / (NET INVESTMENT).
In the 50s Doctor William Sharpe developed the sharpe ratio, where: SR = (net return rate - riskless rate)/(volatility of the investment vehicle)
Actually, both formulas are wrong if you plan to deploy them as a CONTRAST AND COMPARISON TOOL. Why? ROI was designed to measure efficacy and efficiency in terms of how an investment retrieves money and shoots in value added. But the risks and hazards surrounding the journey are not taken into account!
Meanwhile, The Sharpe Ratio works with 3 rates: the net rate of return on any given investment, the standard deviation or volatility of such a net return rate on our investment and a free risk rate. That is the flaw! The riskless rate!
The author assumes about the WEIGHTED AVERAGE COST OF CAPITAL (WACC) to be equal to all investor, for every individual investment and accounting itself the same value
If we merge the 2 formulas the final recipe could turn out to be: (%net rate of return on the investment - %WACC rate) / (%volatility or standard deviation accrued during the investment's time line)
Example: a venture yields 1% net monthly, the volatility of such a venture is 0.05% mothly and the net cost (wacc) is around 0.8% monthly? WHAT IS THE ANUALLY COMPOUNDED rate for such an investment?
We have to apply our converter, so: (1.01)^12=1.12682503013197 this is an annual yield = 12.682503013197%, (1.008)^12=1.10033869371615 this is an annual WACC = 10.033869371615% and finally 0.05*(12)^0.5 = 0.173205080756888% annual volatility. The big picture it is as follows: (12.682503013197% - 10.033869371615%)/(0.173205080756888%)
The final result of our rate = 0.152918934595223 annual. This rate has to be compared against past rates, the industry standard or other alternative investments.
This time around, ROI will be shreded, so thus risk as a third element can be added as a matter of capital account. The original formula states: ROI = (NET INCOME-NET INVESTMENT) / (NET INVESTMENT).
In the 50s Doctor William Sharpe developed the sharpe ratio, where: SR = (net return rate - riskless rate)/(volatility of the investment vehicle)
Actually, both formulas are wrong if you plan to deploy them as a CONTRAST AND COMPARISON TOOL. Why? ROI was designed to measure efficacy and efficiency in terms of how an investment retrieves money and shoots in value added. But the risks and hazards surrounding the journey are not taken into account!
Meanwhile, The Sharpe Ratio works with 3 rates: the net rate of return on any given investment, the standard deviation or volatility of such a net return rate on our investment and a free risk rate. That is the flaw! The riskless rate!
The author assumes about the WEIGHTED AVERAGE COST OF CAPITAL (WACC) to be equal to all investor, for every individual investment and accounting itself the same value
If we merge the 2 formulas the final recipe could turn out to be: (%net rate of return on the investment - %WACC rate) / (%volatility or standard deviation accrued during the investment's time line)
Example: a venture yields 1% net monthly, the volatility of such a venture is 0.05% mothly and the net cost (wacc) is around 0.8% monthly? WHAT IS THE ANUALLY COMPOUNDED rate for such an investment?
We have to apply our converter, so: (1.01)^12=1.12682503013197 this is an annual yield = 12.682503013197%, (1.008)^12=1.10033869371615 this is an annual WACC = 10.033869371615% and finally 0.05*(12)^0.5 = 0.173205080756888% annual volatility. The big picture it is as follows: (12.682503013197% - 10.033869371615%)/(0.173205080756888%)
The final result of our rate = 0.152918934595223 annual. This rate has to be compared against past rates, the industry standard or other alternative investments.
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