Can be defined as the rate of return that the firm makes on its invested capital?
Return on capital (ROC), or return on invested capital (ROIC), is a ratio used in finance, valuation and accounting, as a measure of the profitability and value-creating potential of companies relative to the amount of capital invested by shareholders and other debtholders.[1] It indicates how effective a company is at turning capital into profits. Show The ratio is calculated by dividing the after tax operating income (NOPAT) by the average book-value of the invested capital (IC). Return on invested capital formula[edit]ROIC = NOPAT/Average Invested CapitalThere are three main components of this measurement that are worth noting:[2]
Some practitioners make an additional adjustment to the formula to add depreciation, amortization, and depletion charges back to the numerator. These charges are considered by some to be "non-cash expenses" which are often included as part of operating expenses. The practice of adding these back is said to more closely reflect the cash return of a firm over a given period of time. However, others (such as Warren Buffett) argue that depreciation should not be excluded seeing that it represents a real cash outflow. When a company purchases a depreciating asset, the cost is not immediately expensed on the income statement. Instead, it is capitalized on the balance sheet as an asset. Over time, the depreciation expenses on the income statement will reduce the asset value on the balance sheet. In turn, depreciation represents the delayed expensing of the initial cash outflow that purchased the asset, and is thus a rather liberal accounting practice. Relationship with WACC[edit]Because financial theory states that the value of an investment is determined by both the amount of and risk of its expected cash flows to an investor, it is worth noting ROIC and its relationship to the weighted average cost of capital (WACC). The cost of capital is the return expected from investors for bearing the risk that the projected cash flows of an investment deviate from expectations. It is said that for investments in which future cash flows are incrementally less certain, rational investors require incrementally higher rates of return as compensation for bearing higher degrees of risk. In corporate finance, WACC is a common measurement of the minimum expected weighted average return of all investors in a company given the riskiness of its future cash flows. Since return on invested capital is said to measure the ability of a firm to generate a return on its capital, and since WACC is said to measure the minimum expected return demanded by the firm's capital providers, the difference between ROIC and WACC is sometimes referred to as a firm's "excess return", or "economic profit". See also[edit]
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What is the rate of return on an investment called?Return on investment (ROI) is a metric used to understand the profitability of an investment. ROI compares how much you paid for an investment to how much you earned to evaluate its efficiency.
What type of ratio is return on invested capital?ROIC stands for Return on Invested Capital and is a profitability or performance ratio that aims to measure the percentage return that a company earns on invested capital. The ratio shows how efficiently a company is using the investors' funds to generate income.
What defines invested capital?What Is Invested Capital? Invested capital is the total amount of money raised by a company by issuing securities to equity shareholders and debt to bondholders, where the total debt and capital lease obligations are added to the amount of equity issued to investors.
What is the definition of ROI?Return on Investment (ROI) A calculation of the monetary value of an investment versus its cost. The ROI formula is: (profit minus cost) / cost. If you made $10,000 from a $1,000 effort, your return on investment (ROI) would be 0.9, or 90%.
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