ROI and payback period are essential tools for evaluating investments in case interviews. Whether the question is about a marketing campaign, new product launch, or capital expenditure, you'll need these formulas.
What ROI and Payback Measure
ROI (Return on Investment) answers: "How much do I get back for every dollar invested?"
Payback Period answers: "How long until I recover my initial investment?"
Both help decision-makers choose between alternatives and assess risk. Shorter payback = lower risk. Higher ROI = better returns.
ROI Formula
ROI = (Gain from Investment - Cost of Investment) / Cost of Investment × 100%Or simplified: ROI = Net Profit / Investment × 100%
Worked Example 1: Marketing Campaign
A company spends $500K on a digital campaign. It generates $750K in attributable revenue with 40% gross margin.
Step 1: Gross profit from campaign = $750K × 40% = $300K
Step 2: Net gain = $300K - $500K = -$200K (wait, that's a loss!)
Step 3: ROI = -$200K / $500K = -40%
Insight: Revenue isn't profit! Always use profit, not revenue. This campaign actually lost money.
Worked Example 2: New Product
Investment: $2M. Expected annual profit: $600K for 5 years.
Total gain: $600K × 5 = $3M
ROI: ($3M - $2M) / $2M = 50% over 5 years, or ~10% annually
Payback Period Formula
Simple Payback (Equal Cash Flows)
Payback Period = Initial Investment / Annual Cash FlowExample: Manufacturing Equipment
Cost: $1.2M. Annual savings: $400K.
Payback: $1.2M / $400K = 3 years
Cumulative Payback (Unequal Cash Flows)
When cash flows vary by year, add them up until you recover the investment.
| Year | Cash Flow | Cumulative |
|---|---|---|
| 0 | -$500K | -$500K |
| 1 | +$150K | -$350K |
| 2 | +$200K | -$150K |
| 3 | +$250K | +$100K |
Payback: Between Year 2 and 3. More precisely: 2 + ($150K/$250K) = 2.6 years
How Interviewers Use ROI/Payback
Common question patterns:
- "Should we proceed with this investment?" — Calculate ROI, compare to hurdle rate
- "Which option should we choose?" — Compare ROI or payback across alternatives
- "What's the risk profile?" — Shorter payback = lower risk
- "What assumptions drive this?" — Sensitivity analysis on key variables
5 Common Mistakes
- Using revenue instead of profit — Always subtract costs!
- Forgetting the time dimension — 50% ROI over 10 years vs 1 year is very different
- Ignoring opportunity cost — Compare to alternatives, not just $0
- Mixing up percentages and absolutes — Keep units consistent
- Ignoring time value of money — For quick cases, simple payback is fine; for detailed analysis, mention NPV
5 Practice Questions
Q1: A $100K marketing spend generates $180K revenue with 30% margin. What's the ROI?
Q2: Equipment costs $800K and saves $250K/year. What's the payback period?
Q3: Two projects: A has 25% ROI over 2 years; B has 40% ROI over 5 years. Which is better annually?
Q4: Investment of $2M generates profits of $400K, $500K, $600K, $700K in years 1-4. What's the payback?
Q5: A company's hurdle rate is 15%. Should they pursue a project with 18% ROI?
Answers: Q1: -6.7% (loss!), Q2: 3.2 years, Q3: A=12.5%/yr, B=8%/yr—A is better, Q4: ~3.7 years, Q5: Yes, exceeds hurdle
Where to Practice More
- Case Math Drills — Practice ROI scenarios
- Formulas Cheat Sheet — Quick reference
- 14-Day Plan — Structured practice
ROI and payback are your friends. Master them and investment cases become straightforward.
Also targeting finance roles? ROI concepts are even more critical in investment banking and private equity interviews.