Return on Invested Capital
Return on invested capital (ROIC) or also called return on capital is a financial ratio employed to measure nominal company’s return that is earned by capital invested in operating asset. Basically return on invested capital is a similar ratio to return on asset but is more detailed and more exact.
This ratio is a ratio of a firm and calculation of it includes both debt and equity capital and also do not excludes interest for financial liabilities of the company.
So why would be this ratio so significant? Well, if calculated correctly, this ratio is very important as well as return on equity because it shows what value can be created by company compared to its cost of capital. If company’s return on capital is lower than its cost of capital, that would mean that such business is not worth to be expanded. But if return on invested capital is much higher than cost of capital, then huge profits (and value) can be created by expansion. Of course, this works theoretically, but in practice everything is more difficult, because the business model should create the same return on new investments as was in the calculations which is not very probable under real market conditions. Basically, ROIC is valuable when the profitability of new projects sustains the same level as on previous activity of the company.
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