Hong Life CalculatorsUnderstanding the ROIC calculator — concept and principle
Return on invested capital (ROIC) measures how much after-tax operating profit a company earns on the money lenders and shareholders have put into it. Investors compare ROIC with the weighted average cost of capital (WACC) to judge whether a business creates value.
How it is calculated
- NOPAT = EBIT × (1 − effective tax rate).
- Average invested capital = (debt at start + debt at end) ÷ 2 + (equity at start + equity at end) ÷ 2, using interest-bearing debt.
- ROIC = NOPAT ÷ average invested capital.
- Pre-tax ROIC = EBIT ÷ average invested capital.
- ROIC − WACC, in percentage points.
The principle
A company's investors expect a return for the risk they take, measured by WACC. If the business earns more than that on the capital it uses, every extra dollar invested adds value; if it earns less, growth destroys value. NOPAT is used because it is the profit available to all capital providers, before interest and after operating taxes. Averaging the capital over the year matches a full year's profit with the capital that produced it.
Worked example
Default inputs: EBIT 12,000,000 USD, tax 22%, debt 30,000,000 → 34,000,000 USD, equity 46,000,000 → 50,000,000 USD, WACC 8%.
- NOPAT = 12,000,000 × 0.78 = 9,360,000 USD.
- Average capital = 32,000,000 + 48,000,000 = 80,000,000 USD.
- ROIC = 9,360,000 ÷ 80,000,000 = 11.7%.
- Pre-tax ROIC = 12,000,000 ÷ 80,000,000 = 15%.
- ROIC − WACC = 11.7 − 8 = 3.7 points: return above the cost of capital.
| Operating profit (EBIT) for the year | Return on invested capital (ROIC) |
|---|---|
| 3e+06 | 2.93% |
| 6e+06 | 5.85% |
| 9e+06 | 8.77% |
| 1.2e+07 | 11.7% |
| 1.5e+07 | 14.63% |
| 1.8e+07 | 17.55% |
| 2.4e+07 | 23.4% |
How to read the result
A persistent positive spread suggests a competitive advantage. A spread near zero means growth adds little value; a negative spread means the business is not covering the cost of its capital. Analysts often adjust capital, for example subtracting excess cash or adding lease liabilities; enter adjusted figures to see those versions.
Common mistakes
- Using net income instead of NOPAT.
- Including non-interest-bearing liabilities (such as payables) in invested capital.
- Comparing ROIC with a WACC computed on a different basis.
- Using year-end capital after a large acquisition.
Frequently asked questions
What is a good ROIC?
One reliably above WACC; how far above varies by industry.
Why compare ROIC with WACC?
Because value is created only when returns on capital exceed the cost of that capital.
Should I subtract excess cash?
Many analysts do, because idle cash is not used in operations; be consistent across companies.
Sources: Koller, Goedhart & Wessels (McKinsey), Valuation: Measuring and Managing the Value of Companies (ROIC) · Damodaran, A., Return on Capital (ROC), Return on Invested Capital (ROIC) and Return on Equity (ROE): Measurement and Implications (NYU Stern working paper)