The return on invested capital is the percentage amount that a company is making for every percentage point over the [Cost of Capital|Weighted Average Cost of Capital (WACC). More specifically the return on investment capital is the percentage return that a company makes over its invested capital. However, the invested capital is measured by the monetary value needed, instead of the assets that were bought. Therefore invested capital is the amount of long-term debt plus the amount of common and preferred shares.
Use the following formula to calculate the Return on invested capital:
Invested Capital – This is the total amount of long term debt plus the total amount of equity, whether it is from common or preferred. The last part of invested capital is to subtract the amount of cash that the company has on hand.
Bob is in charge of Rolly Polly Inc., a company that specializes in heavy agricultural and construction equipment. Bob has been curious as to how his company has been performing as of late and decides to look at the company’s return on invested capital analysis. Surprisingly, the company does not keep track of the return on invested capital ratio. Bob decides that he will go ahead and run the ROIC analysis, and obtains the following information:
Plugging these numbers into the formula Bob finds the following:
$20 million – (20 million * 35%) = $13 million
$13 million/($25 milion + $75 million) = .13 or 13% = ROIC
To see how well the company is actually generating a return, Bob then compares the 13% to the WACC which is 11%. Thus, Bob find that the company is generating 2% more in profits than it cost to keep operations going.
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