Introduction & Chapter 8

PART IV: Investment Decision Making - From Financial Impact to Investment Choice

A financial model tells you what might happen. An investment decision asks: Is it worth doing? That distinction is important.

Teams can build accurate financial models and still make poor investment decisions. They may calculate revenue, costs, profit, and cash flow correctly but fail to connect those numbers to the actual decision facing management. Investment decision-making is about comparing the resources required to pursue an opportunity with the value that opportunity is expected to create. This requires more than one financial calculation. It requires judgment.

The Purpose of Investment Analysis

When organisations invest, they give something up today in exchange for an expected benefit in the future. That investment might involve:

• launching a new product

• opening a new location

• purchasing equipment

• implementing technology

• entering a new market

• acquiring another company

• expanding production

• hiring additional employees

• developing new capabilities

The fundamental question is always: Will the expected benefits justify the resources and risks required? Different financial tools answer different versions of that question.

The Investment Decision Toolkit

This part of the manual introduces several tools that case teams can use to evaluate investments.

• Chapter 8: ROI: How profitable is the investment relative to its cost?
• Chapter 9: NPV: Does the investment create value after considering the time value of money?
• Chapter 10: IRR: What rate of return does the investment generate?
• Chapter 11: Comparing Investment Alternatives: Which investment creates the greatest value?
• Chapter 12: Sensitivity and Scenario Analysis: How robust is the decision when assumptions change?
• Chapter 13: Decision Making Under Uncertainty:  How strong is a decision when the future cannot be predicted with confidence?

These tools should not be viewed as competing formulas. They answer different questions.

Discover Your Mad Skills Principle

The goal is not to calculate the number. The goal is to use the number to make the decision.

A judge does not need to know that you can calculate ROI. They need to understand:

• what the ROI means

• whether it is attractive

• what assumptions drive it

• how it compares with alternatives

• what risks could change the result

• and what you recommend management do

The calculation is the evidence. The decision is the point.

Deciphering Case Characteristics

Before choosing an investment metric, ask:

What decision is being made?

1. Are we deciding whether to invest at all?
2. Are we choosing between two projects?
3. Are we deciding how much to invest?
4. Are we deciding when to invest?

What information does the case provide?

Do we have:

• initial investment?

• annual returns?

• costs?

• cash flows?

• timing?

• discount rate?

• comparable investments?

What level of analysis is appropriate?

Not every case requires a full discounted cash flow model.

Sometimes a quick ROI calculation is exactly what is required.

Other times, ROI is insufficient, and the team needs NPV, IRR, or sensitivity analysis.

The skill is knowing the difference.

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PART IV: INVESTMENT DECISION MAKING

The chapters that follow build progressively.

Start with the simplest question:

• How much return are we getting for what we are investing?

Then move toward more sophisticated questions:

• When do we receive that return?
• What is the value of those future cash flows today?
• What rate of return does the investment generate?
• How confident are we that the investment will actually create value?

This progression allows students to understand not just the formulas, but why the tools exist.

Chapter 8: ROI - Simple Investment Decisions

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Learning Objectives

By the end of this chapter, you should be able to:

• explain what ROI measures

• calculate ROI for a simple investment

• identify situations where ROI is useful

• distinguish between annual and cumulative ROI

• compare investment alternatives using ROI

• recognise the limitations of ROI

• communicate ROI effectively in a case presentation

• understand when a more sophisticated investment tool is required

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Why This Matters

One of the most common questions in a business case is: Is this investment worth it? Sometimes you need a sophisticated financial model to answer that question. Sometimes you don't.

If a company is considering spending $1 million on an initiative and expects to generate $1.5 million in returns, a simple calculation can provide an immediate first look at the attractiveness of the investment. That calculation is Return on Investment, or ROI. ROI is one of the simplest financial tools available to a case-solving team. And that simplicity is its greatest strength. It is also one of its greatest limitations.

What Is ROI?

ROI measures the return generated by an investment relative to the cost of that investment. The basic formula is: ROI = (Return − Investment Cost) ÷ Investment Cost. The result is normally expressed as a percentage. For example:

An organisation invests:

• $1 million

The investment produces:

• $1.5 million

The gain is:

• $500,000

Therefore:

• ROI = ($1.5M − $1.0M) ÷ $1.0M
• ROI = 50%

The investment generated a 50% return relative to the amount invested.

What Is ROI Actually Telling You?

ROI answers a relatively simple question: How much return did we generate relative to what we invested? This makes ROI particularly useful for quick comparisons. Suppose you have two alternatives:

	Investment	Return	ROI
Project A	$1M	$1.5M	50%
Project B	$5M	$6M	20%

Project A has the higher ROI. At first glance, that may suggest Project A is more attractive. But notice something important.

• Project B generates:
• $1 million of gain
• while Project A generates:
• $500,000 of gain.

So which project is better? That depends on the decision. This is one of the first important lessons of financial analysis: A financial metric does not make the decision by itself.

When to Use ROI

ROI works particularly well when you need a:

• Quick financial check
  • You can calculate ROI quickly without building a complex model.
• Simple comparison
  • ROI can help compare alternatives when the investments have reasonably similar characteristics.
• Communication tool
  • Executives and judges can understand a percentage return quickly.
• Early-stage estimate
  • During the early stages of case solving, ROI can help determine whether an idea is financially promising before the team spends significant time developing a detailed model.

ROI in Case Competitions

ROI is particularly useful when time is limited. Imagine your team has three potential recommendations. You don't yet know which one deserves deeper analysis. You could estimate:

• initial investment

• expected return

• ROI

for each alternative. This gives the team a quick way to identify which options deserve further investigation. ROI can therefore function as a screening tool. It does not necessarily provide the final investment decision.

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A Worked Example

Imagine a retailer is considering a new customer loyalty program. The team estimates:

• Initial investment: $2 million
• Expected financial return: $3 million

The calculation is:

• ROI = ($3M − $2M) ÷ $2M
• ROI = $1M ÷ $2M
• ROI = 50%

The team can therefore state: "The proposed loyalty program generates an estimated 50% ROI." But don't stop there. The next question should be: What assumptions create that 50%? Perhaps the model assumes:

• 100,000 customers participate

• 20% increase in purchase frequency

• $30 incremental contribution per customer

• Implementation costs of $2 million

Now the ROI becomes much more useful. The team can identify the assumptions that need to be tested.

The Difference Between Return and Profit

Be careful with terminology. When calculating ROI, teams sometimes use "return" to mean total revenue. That can be misleading.

• If you invest $1 million in a marketing campaign and generate $2 million in additional sales, that does not necessarily mean you earned $1 million.

You must consider the costs associated with generating those sales. A useful question is: What financial benefit are we actually measuring? Depending on the case, this might be:

• incremental profit

• incremental operating income

• savings

• cash flow

• investment proceeds

The appropriate measure depends on the decision.

Annual vs. Cumulative ROI

Another important distinction is timing. Imagine an investment of $1 million generates:

• Year 1: $200,000

• Year 2: $300,000

• Year 3: $500,000

The total return is: $1 million

The cumulative gain relative to the original investment is therefore: 0%

But that does not mean the investment was necessarily unsuccessful. The organisation received cash flows over three years. ROI by itself does not tell us how quickly those returns arrived. This is a major limitation.

ROI Does Not Consider the Time Value of Money

A dollar received today is generally worth more than a dollar received several years from now.

ROI does not automatically account for this.

Consider two investments:

Investment A

• Invest $1 million.
• Receive $1.5 million next year.

Investment B

• Invest $1 million.
• Receive $1.5 million ten years from now.

A simple ROI calculation gives both investments the same: 50% ROI. But economically, they are very different investments. Investment A returns the money much sooner. Investment B ties up the organisation's capital for much longer. This is one reason we eventually need tools such as NPV and IRR.

ROI Does Not Capture Risk

Two investments can have identical ROI calculations but dramatically different levels of risk.

Imagine:

Project A

• 50% ROI
• High probability of success

Project B

• 50% ROI
• Highly uncertain market

The percentage alone does not tell us which investment should be selected. This is why financial analysis must be connected to:

• strategic fit

• implementation capability

• market conditions

• uncertainty

• risk

• organizational capacity

Financial metrics are evidence. They are not the entire decision.

ROI Does Not Tell You the Size of the Opportunity

Consider:

	Investment	Gain	ROI
A	$100K	$50K	50%
B	$10M	$2M	20%

Project A has a better ROI. Project B creates a much larger absolute gain. If the organisation has significant excess capital and needs to maximise total value creation, Project B might be preferable. If capital is extremely constrained, Project A might be more attractive. Again: The metric must be interpreted in the context of the decision.

The ROI Trap

One of the most common mistakes in case competitions is treating the highest ROI as automatically meaning "best investment."

It doesn't.

Suppose your team recommends the project with the highest ROI. A judge might ask: "Why did you choose that project?" If your answer is: "Because it has the highest ROI," you have not really answered the strategic question.

A stronger answer might be: "We selected Project A because it generates an attractive 50% ROI while requiring only $1 million of investment, which is consistent with the organisation's available capital. Although Project B produces a larger absolute profit, its capital requirement is significantly higher and would limit our ability to fund other strategic priorities." Now the financial metric is supporting the decision.

Coach's Lens

When a team gives me an ROI calculation, I want them to answer four questions:

1. What are we investing? What is the initial cost?
2. What are we getting back? What exactly constitutes the return?
3. When do we get it? Is it immediate, annual, or spread over several years?
4. What could change it? Which assumptions are most important?

If the team can answer those four questions, the ROI becomes much more useful.

ROI as a Screening Tool

One of the best uses of ROI in a case is to quickly screen alternatives. Imagine a team is considering five initiatives. Rather than immediately building five complex financial models, estimate the ROI of each.

Initiative	Investment	Estimated Gain	ROI
A	$1M	$600K	60%
B	$3M	$900K	30%
C	$2M	$1M	50%
D	$5M	$750K	15%
E	$500K	$50K	10%

The team might decide to investigate A and C more deeply. This saves time. And in a case competition, time is a resource.

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From ROI to Deeper Analysis

Once ROI suggests an investment may be attractive, ask: Do we need more analysis? The answer is often yes. You may want to investigate:

• timing of cash flows

• cost of capital

• project life

• risk

• alternative investments

• sensitivity to assumptions

This is where the financial toolkit progresses from:

ROI to NPV to IRR to Sensitivity Analysis

Each tool adds another dimension to the decision.

Using ROI in Excel

ROI is straightforward to calculate in Excel. For example, if:

• investment is in cell B2

• return is in cell B3

the calculation can be represented conceptually as: (Return − Investment) / Investment. Excel then converts the result into a percentage.

But remember: The formula is the easy part. The difficult part is determining what should go into the formula.

Building the ROI Story

A good case presentation should not simply show: ROI = 48.6%. Instead, build the financial story.

• Investment: $2.0M
  
• Incremental Financial Benefit: $3.0M
  
• Net Gain: $1.0M
  
• ROI: 50%
  
• Decision

Proceed, subject to key assumptions. Now the judge can follow the logic.

Presenting ROI to Judges

Keep the presentation simple. Highlight:

• initial investment

• financial benefit

• ROI

• timing

• key assumptions

Avoid burying the calculation in a spreadsheet screenshot. Your audience should understand the conclusion in seconds. For example: $2M investment → $3M return → 50% ROI. Then explain the assumptions that make that result credible.

A Stronger Financial Statement

Instead of: "Our recommendation has a 50% ROI."

Try: "Our $2 million investment is expected to generate $3 million in incremental financial benefit, producing a 50% ROI. The result is driven primarily by a 15% customer adoption assumption and a $30 contribution per customer."

Now the judges understand:

investment → return → metric → assumptions

That is a financial story.

Sensitivity Thinking

Even when using ROI, think about what happens if your assumptions change. Suppose the base case is: 50% ROI. But:

• Conservative Case: 30% ROI
• Base Case: 50% ROI
• Upside Case: 75% ROI

Now you have a much stronger understanding of the investment. The question becomes: Does the investment remain attractive if our assumptions are wrong? That question becomes central to the sensitivity analysis later in this part.

Mad Skills Drill

Choose an investment from a previous case. Calculate:

1. Initial Investment: How much does the organisation have to spend?
2. Financial Benefit: What incremental profit, savings, or return does the investment generate?
3. Net Gain: Benefit minus investment.
4. ROI: Net gain divided by investment.
5. Key Assumption: What assumption has the greatest impact on the result?

Then change that assumption. What happens to ROI? This is the beginning of sensitivity analysis.

Common Mistakes

• Using revenue as the return. Sales are not necessarily profit.
• Ignoring timing. A 50% return next year is different from a 50% return ten years from now.
• Choosing the highest ROI automatically. ROI does not measure total value.
• Ignoring investment size. A tiny project can have an impressive ROI but create very little absolute value.
• Presenting ROI without assumptions. A percentage without supporting logic is difficult to trust.
• Treating ROI as the final answer. ROI is often a starting point rather than the complete investment analysis.

Deciphering the Decision

When you see an ROI question in a case, don't immediately reach for the formula. Ask: What decision is management actually trying to make? Then ask: Is ROI sufficient to answer that decision?

• If the case requires a quick comparison, ROI may be enough.
• If timing is important, consider NPV.
• If the question is about the rate of return, consider IRR.
• If uncertainty is significant, use sensitivity or scenario analysis.

The skill is not knowing every formula. The skill is knowing which tool answers the question.

Chapter Summary

ROI is one of the simplest ways to evaluate an investment. It provides a quick measure of the return generated relative to the investment required. That makes it useful for:

• quick screening

• simple comparisons

• early financial analysis

• communicating financial attractiveness

But ROI has important limitations. It does not automatically account for:

• timing

• time value of money

• risk

• absolute value creation

• differences in investment size

Therefore, ROI should be used as part of the investment decision process rather than as an automatic decision rule.

Key Takeaways

✓ ROI measures return relative to investment.

✓ ROI is useful for quick financial comparisons.

✓ ROI can be an effective screening tool.

✓ Always define what "return" actually means.

✓ Consider investment size, not just percentage return.

✓ Consider when the return occurs.

✓ Don't assume the highest ROI automatically represents the best investment.

✓ Make the assumptions behind the ROI visible.

✓ Use sensitivity analysis when assumptions are uncertain.

✓ Move to NPV or IRR when the decision requires deeper analysis.

✓ The goal is not to calculate ROI.

✓ The goal is to use ROI to make a better decision.

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Looking Ahead

ROI gives us a quick view of investment attractiveness. But it treats a dollar received today and a dollar received several years from now too similarly. That raises an important question: What are those future cash flows actually worth today? In the next chapter, we move to Net Present Value (NPV) and introduce the time value of money—the next step in making more sophisticated investment decisions.