return on capital

Examples of return on capital in the following topics:

• Decision Criteria

  • The main considerations of working capital management decisions are (1) cash flow/ liquidity and (2) profitability/return on capital.
  • Working capital management decisions are, therefore, not made on the same basis as long-term decisions, and working capital management applies different criteria in decision making: the main considerations are (1) cash flow/liquidity and (2) profitability/ return on capital (of which cash flow is generally the most important).
  • In this context, the most useful measure of profitability is return on capital (ROC).
  • The result is shown as a percentage, determined by dividing relevant income for the 12 months by capital employed; return on equity (ROE) shows this result for the firm's shareholders.
  • Firm value is enhanced when, and if, the return on capital, which results from working-capital management, exceeds the cost of capital, which results from capital investment decisions as above.

• Return on Investment

  • Return on investment (ROI) is one way of considering profits in relation to capital invested.
  • Return on investment (ROI) is one way of considering profits in relation to capital invested.
  • Return on assets (ROA), return on net assets (RONA), return on capital (ROC) and return on invested capital (ROIC) are similar measures with variations on how 'investment' is defined .
  • The purpose of the "return on investment" metric is to measure per-period rates of return on dollars invested in an economic entity.
  • Return on assets (ROA), return on net assets (RONA), return on capital (ROC) and return on invested capital (ROIC) are similar measures with variations on how 'investment' is defined.

• Evaluating Interest Rates

  • The cost of capital, in a financial market equilibrium, will be the same as the market rate of return on the financial asset mixture the firm uses to finance capital investment.
  • The return expected on debt depends upon the credit rating of the company, which takes into account a number of factors to determine how risky loaning funds to a company will be.
  • When evaluating short-term profitability, company's may use measures such as return on capital.
  • Firm value is enhanced when, and if, the return on capital, which results from working-capital management, exceeds the cost of capital, which results from capital investment decisions.
  • Debtors management involves identifying the appropriate credit policy -- i.e. credit terms which will attract customers -- such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and, hence, return on capital (or vice versa).

• Cost of Capital Considerations

  • Cost of capital is important in deciding how a company will structure its capital so to receive the highest possible return on investment.
  • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
  • A company's securities typically include both debt and equity, so one must therefore calculate both the cost of debt and the cost of equity to determine a company's cost of capital.
  • The expected return on an asset is compared to the cost of capital to invest in the asset.
  • Describe the influence of a company's cost of capital on its capital structure and investment decisions

• Cost of capital

  • Firms usually calculate a single cost of capital number, and, under economic theory, will only pursue projects with an expected return greater than the cost of capital.
  • It determines the minimum return that investors expect for providing capital to the company.
  • In order for an investment to be worthwhile, the expected return on capital has to be higher than the cost of capital.
  • The cost of debt is composed of the interest rate paid on the bonds or loans.
  • The plant will not be built unless the projected returns exceed the cost of capital.

• Defining the Cost of Capital

  • The cost of capital is the rate of return that could be earned on an investment with similar risk.
  • The cost of capital is used to evaluate new projects of a company, as it is the minimum return that investors expect for providing capital to the company.
  • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
  • A company's securities typically include both debt and equity; therefore, one must calculate both the cost of debt and the cost of equity to determine a company's cost of capital.
  • The cost of capital can be compared to the internal rate of return (IRR) of a project or investment.

• The Marginal Cost of Capital

  • The marginal cost of capital can also be discussed as the minimum acceptable rate of return or hurdle rate.
  • The investment in capital is logically only a good decision if the return on the capital is greater than its cost.
  • Also, a negative return is generally undesirable.
  • If it is determined that the dollars invested in raising this extra capital could be allocated toward a greater or safer return if used differently, according to the firm, then they will be directed elsewhere.
  • For this we must look into marginal returns of capital, which can be described as the gains or returns to be had by raising that last dollar of capital.

• Impact of the SML on the Cost of Capital

  • The plotted location of an instrument on the SML has consequences on its price, return, and cost of capital it contributes to a firm.
  • The security market line is a graphical representation of the capital asset pricing model that illustrates the idea that investments are priced efficiently based on the expected return and beta-value (risk).
  • An instrument plotted on the SML can be thought of to be fairly priced for the amount of expected return.
  • The location of a financial instrument above, below, or on the security market line will lead to consequences for a company's cost of capital.
  • Describe the impact of the SML on determining the cost of capital

• Relationships between ROA, ROE, and Growth

  • Return on assets is a component of return on equity, both of which can be used to calculate a company's rate of growth.
  • In review, return on equity measures the rate of return on the ownership interest (shareholders' equity) of common stockholders.
  • In other words, return on assets makes up two-thirds of the DuPont equation measuring return on equity.
  • Return on assets gives us an indication of the capital intensity of the company.
  • Discuss the different uses of the Return on Assets and Return on Assets ratios

• Differences Between Required Return and the Cost of Capital

  • This required amount of return will ultimately equal the cost of capital, as the required rate from the investor is now a cost being put on the borrower.
  • Now, cost of capital for a given investor will always equate to the required return.
  • This is where the concept of weighted average cost of capital (WACC) enters the equation, as there may be more than one investor with varying rates of return.
  • In the above equation, you have D as total debt, E as total equity, Kd as the required return on debt, and Ke as the required return on equity.
  • Ultimately, the difference between the cost of capital and the required return is both one of perspective (borrower looks at cost of capital for a project; investors look at required return) as well as the potential for a WACC, which integrates various required returns for a single investment project.