Return on Invested Capital Formula (Table of Contents)
- Return on Invested Capital Formula
- Examples of Return on Invested Capital Formula (With Excel Template)
- Return on Invested Capital Formula Calculator
Return on Invested Capital Formula
Return on Invested Capital is a profitability ratio that determines how well a company is using its capital to generate returns. Return on Invested Capital formula can be calculated by dividing NOPAT by total invested capital in the company.
Return on Invested Capital Formula
Where:
- NOPAT – It can be described as the operating profit of the company minus the income taxes.
NOPAT = EBIT (1-t) where EBIT is Earnings before Interest and Taxes
- Invested Capital – It can be described as the total amount of capital invested in the company by both shareholders and lenders.
Invested Capital – Debt + Equity – Cash & Cash Equivalents
Examples of Return on Invested Capital Formula (With Excel Template)
Let’s take an example to understand the calculation of Return on Invested Capital formula in a better manner.
Return on Invested Capital Formula – Example #1
Let’s take the example of a company X whose EBIT is $15000 and the tax rate is at 30%. Similarly, the total debt is $20000 and total equity is $30000 and cash on hand is $5000.
NOPAT is calculated using the formula given below
NOPAT = EBIT (1-t)
- NOPAT= $15000 (1-0.3)
- NOPAT= $15000 * 0.7
- NOPAT = $10500
Invested Capital is calculated using the formula given below
Invested Capital = Debt + Equity – Cash & Cash Equivalents
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- Invested Capital = $20000 + $30000 – $5000
- Invested Capital = $45000
ROIC is calculated using the formula given below
Return on Invested Capital = NOPAT / Invested Capital
- ROIC = $10500 / $45000
- ROIC = $0.23
Return on Invested Capital Formula – Example #2
Let’s take an example of a company Reliance whose EBIT is Rs 45725 Cr and tax rate is at 30%. Total Shareholder’s equity is Rs 3,14,632 Cr, long term debt is Rs 81,596 Cr and short term debt are Rs 15, 239 Cr. Cash on hand is Rs 2732 Cr.
NOPAT is calculated using the formula given below
NOPAT = EBIT (1-t)
- NOPAT = 45725 * (1-0.3)
- NOPAT = 45725 * 0.7
- NOPAT = Rs 32007.5 Cr
Invested Capital is calculated using the formula given below
Invested Capital = Debt + Equity – Cash & Cash Equivalents
- Invested Capital = 81596+ 15239 + 314632– 2731
- Invested Capital = Rs 408735 Cr
ROIC is calculated using the formula given below
Return on Invested Capital = NOPAT / Invested Capital
- ROIC = Rs 32007.5 / Rs 408735 Cr
- ROIC = 0.078
Return on Invested Capital Formula – Example #3
Let’s take an example of a company Tata Steel whose EBIT is Rs 8176 Cr and tax rate is at 30%. Total Shareholder’s equity is Rs 61,514 Cr, long term debt is Rs 24, 568 Cr and short term debt are Rs 670 Cr. Cash on hand is Rs 4696 Cr.
NOPAT is calculated using the formula given below
NOPAT = EBIT (1-t)
- NOPAT = 8176 (1-0.3)
- NOPAT = 8176 * 0.7
- NOPAT = Rs 5723.2 Cr
Invested Capital is calculated using the formula given below
Invested Capital = Debt + Equity – Cash & Cash Equivalents
- Invested Capital = 24568 + 670 + 61514– Rs 4696
- Invested Capital = Rs 82056 Cr
ROIC is calculated using the formula given below
Return on Invested Capital = NOPAT / Invested Capital
- ROIC = 5723.2 / 82056 Cr
- ROIC = 0.0697
Explanation of Return on Invested Capital Formula
Return on Invested Capital is a profitability ratio that determines how well a company is using its capital to generate returns. It can be calculated by dividing NOPAT by total invested capital in the company. NOPAT is the operating profit of any company or firm minus the income taxes. Invested Capital is the total amount of capital invested by both debtholders and shareholders minus the Cash and Cash equivalents on hand with the company.
There are also adjustments that should be made to prevent uncharacteristic results of ROIC. For example, Earnings from continuing operations may be used while estimating EBIT by removing earnings from discontinued operations and other income. Also while calculating Invested Capital one should add any current portion of short term and long term debt and also remove net assets of discontinued operations.
Relevance and Uses of Return on Invested Capital Formula
Return on Invested Capital can be used as a proxy for the growth of the company. ROIC is generally compared to Weighted Average Cost of Capital for the company. If ROIC is greater than the WACC of the company, then the company is creating value for the shareholders. If ROIC is higher it means that the excess returns generated can be used to reinvest in further development of the company. If ROIC is not greater than WACC, it means that value for the shareholders and debtholders in the company is not created. The Return on Invested Capital formula is more important for some sectors such as petroleum, steel or manufacturing companies etc. since they invest heavily in capital expenditure than other companies.
One of the downsides of using ROIC is it does not tell which segment of the company is actually generating value since it takes the NOPAT as a whole. Sometimes Net Income – Dividends is used in place of NOPAT which yields further opaque results as the return can be generated from even a single occurrence event. ROIC is also used in conjunction with P/E ratio since it lends context to the P/E ratio. Higher P/E ratio for any company viewed in isolation would mean it is overvalued. If it is supported by high ROIC that means that the company is consistently generating higher rates of return and hence must have a higher P/E.
Return on Invested Capital Formula Calculator
You can use the following Return on Invested Capital Calculator.
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Conclusion
Return on Invested Capital is a profitability ratio that determines how well a company is using its capital to generate returns. Return on Invested Capital formula can be calculated by dividing NOPAT by total invested capital in the company. There are certain adjustments that need to be made such as removing earnings from discontinued operations in a calculation of NOPAT. ROIC for any company should be greater than the WACC of the company which would mean the company is generating excess returns. Also, ROIC is used in conjunction with P/E to better understand whether the company’s higher P/E is supported by the consistent returns it is generating over and above WACC.
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