Income InvestedcapI
Invested Capital Defined
• No universal measure of invested capital exists
• Different measures of invested capital reflect different financiers’ perspectives
•Riskier investments are expected to yield a higher ROI
•ROI impacts a company’s ability to succeed, attract financing, repay creditors,and reward owners
optimisticor pessimistic forecasts
• ROI aids in evaluating prior forecast performance
Return on Invested Capital
For Planning and Control
ROI assists managers with:
Components of ROI
Alternative Measures of Invested Capital
Five Common Measures:
• Total Assets • Long-Term Debt Plus Equity • Equity • Market Value of Invested Capital • Investor Invested Capital
ROI Relation
•ROI relates income, or other performance measure, to a company’s level and source of financing
•ROI allows comparisons with alternative investment opportunities
Assists in Forecasting Earnings
• ROI links past, current, and forecasted earnings with
invested capital
• ROI adds discipline
to forecasting
• ROI helps identify
Return on Invested Capital
Application of ROI
ROI is applicable to:
(1) evaluating managerial effective-
ness
(2) assessing profitability
(3) earnings forecasting
• Planning • Budgeting • Coordinating activities • Evaluating opportunities • Control
Components of ROI
Definition
Return on invested capital is defined as:
Components of ROI
Total Assets
• Perspective is that of its total financing base
• Called return on assets (ROA)
ROA: measures operating efficiency/ performance reflects return from all financing does not distinguish return by
financing sources
Components of ROI
Total Assets
Some adjust this invested capital base for:
• ROI relates key summary measures: profits with financing
• ROI conveys return on invested capital from different financing perspectives
Return on Invested Capital
Return on Invested Capital
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Return on Invested Capital
Importance of Joint Analysis
(4) planning and
control
Return on Invested Capital
Evaluating Managerial Effectiveness
• Management is responsible for all company activities
• ROI is a measure of managerial effectiveness in business activities
• Joint analysis is where one measure is assessed relative to another
• Return on invested capital (ROI) is an important joint analysis
Return on Invested Capital
• ROI depends on the skill, resourcefulness, ingenuity, and motivation of management
Return on Invested Capital
Measuring Profitability
• ROI is an indicator of company profitability