ROI calculation

Q: On page F1 of the Quarterly Industry Report, we are curious as to how "Investor ROI" is calculated.  How might we estimate future ROIs?  Can you please enlighten us?

A:  The ROI is, essentially, an IRR calculated with a quarterly compounding period, adjusted to an annual rate.  The investment is the amount put up for a share of stock in Year 2, Quarter 4.  The "cash  inflows" are the dividend payments each quarter plus the ending stock price.  Your finance VP is on his own to estimate stock price.  It is determined by the types of things investors use in the market, plus changes in the market itself.

The formula for calculating Investor's ROI is shown below.

where Dt is equal to the dollar amount of dividends paid in quarter t, Pn is equal to the price of your company's common stock at the end of the most recent quarter, n. P8 is the price at the end of Year 2 (the eighth quarter of historical data) when you began the simulation. The rate, r, is that discount rate that equates the discounted value of dividends and current stock price (discounted quarterly) to the initial stock price. The rate then is annualized by multiplying it by 4 and reported as Investor ROI. The relevant period for the calculations begins in Quarter 9 (Year 3, Quarter 1) when you take over the management of your firm.