Parvesh has started a restaurant by the name of Spices of India by spending Rs.50,00,000. He invested Rs.10,00,000 of his own and took a loan of Rs.40,00,000 from State Bank of India @ 6% per annum. His monthly sales revenue is Rs.20,00,000 and monthly cost of goods sold is Rs.10,00,000. He pays a monthly salary of Rs.2,00,000. The GST rate is 18%. Calculate (a) Return on Investment, and (b) Return on Equity.

Question

Accepted Answer

Given:
- Total Investment = ₹50,00,000
- Own Equity = ₹10,00,000
- Loan from SBI = ₹40,00,000 @ 6% p.a.
- Monthly Sales Revenue = ₹20,00,000
- Monthly COGS = ₹10,00,000
- Monthly Salary = ₹2,00,000

**Step 1: Calculate Annual Figures**
Annual Sales = 20,00,000 × 12 = ₹2,40,00,000
Annual COGS = 10,00,000 × 12 = ₹1,20,00,000
Annual Salary = 2,00,000 × 12 = ₹24,00,000
Annual Interest on Loan = 40,00,000 × 6% = ₹2,40,000

**Step 2: Calculate Profit Before Tax**
PBT = Sales − COGS − Salary − Interest
= 2,40,00,000 − 1,20,00,000 − 24,00,000 − 2,40,000
= ₹93,60,000

(Note: GST is a pass-through tax collected from customers and paid to the government; it does not affect profit calculation.)

**Step 3: Calculate Net Profit After Tax**
Assuming no additional tax information is given, we use PBT as the net profit.
Net Profit = ₹93,60,000

**(a) Return on Investment (ROI):**
ROI = (Net Profit / Total Capital Invested) × 100
= (93,60,000 / 50,00,000) × 100
= **187.2%**

**(b) Return on Equity (ROE):**
ROE = (Net Profit / Equity) × 100
= (93,60,000 / 10,00,000) × 100
= **936%**

The extremely high ROE compared to ROI demonstrates the power of financial leverage — by using borrowed funds at a lower interest rate (6%), Parvesh is able to generate significantly higher returns on his own equity investment.