馃攳
Return on Invested Capital Ratio (ROIC) | Formula & Examples | Calculation - YouTube
Channel: WallStreetMojo
[9]
hello friends welcome to the investment
banking module of Wallstreetmojo
[15]
today's topic is return on invested
capital ratio and Friends this is one of
[22]
the most important topic under ratio
analysis this ratio or this formula of
[29]
ratio is used predominantly for 2
purposes number 1 it is used to
[35]
evaluate how much return a particular
company is giving the 2 purpose of
[41]
evaluation or using this formula is when
the company wants to make any investment
[47]
decision if for example I have some
surplus cash and I want to invest that
[53]
cash in a particular company this
formula or this ratio helps us determine
[59]
what return my investment is going to
generate for me for example if I want to
[66]
invest $1,000,000 in a particular
company return on invested capital of
[72]
that particular company will help me
understand my 1 billion dollar is going
[79]
to generate how much return for me
before we go on to the specific formula
[86]
of computing return on invested capital
let us quickly look at this particular
[90]
chart this is the return on invested
capital of Home Depot country so the
[96]
Home Depot company's return on invested
capital ratio has shown an increasing
[101]
trend over the last 7 years and
currently it stands at 25.89%
[107]
what does 25.89%
[110]
means 25.89% means on every 100
[116]
dollars of capital invested in this
company the company is generating a
[121]
return of 25.89dollars that means if the any particular
[127]
shareholder has invested $100 in the
company the company is generating him a
[132]
return
of 25.89$ and as you can see the return
[137]
on invested capital has shown an
increasing trend for the company over
[142]
the last 7 years that means every
year the company has generated more
[146]
return or more return percentage as
compared to the previous year now let us
[153]
try to understand how to compute the
return on invested capital the return of
[159]
invested capital ratios formula is net
income - dividend divided by debt
[166]
plus equity
therefore there are two components to
[170]
this formula two components to the
return on invested capital formula there
[175]
is a numerator and then we have a
denominator the numerator is net income
[185]
- dividend
whereas denominator is equity + debt
[193]
we will talk about all these component
but basically the ROIC or return on
[200]
invested capital is nothing but net
income that is numerator that we have
[206]
discussed above net income -
dividend / equity + debt if
[215]
you have understood all these four terms
it is easy for us to compute the return
[220]
on invested capital for any company let
us start with the term net income what
[226]
are the term net income means net income
means the net profit which the company
[232]
has generated from its operations okay
net profit for the year the company has
[238]
generated and whether it's a pre-tax
profit or post-tax profit it is a
[243]
post-tax profit that means after doing
all the activities what is the net
[249]
profit after tax that the company has
generated the company is no more going
[254]
to pay any tax on these amount this is
the amount which is after-tax then what
[260]
is dividend dividend is that component
which the company has to pay to its
[266]
reference preferred stockholders or
equity stockholders or common
[271]
stockholders so if there is any dividend
which needs to or a perma your annual
[275]
return which needs to be paid to those
capital holders that is called as
[281]
dividend so we have discussed about the
numerator piece
[284]
what is denominator denominator is
equity + debt friends we all know
[290]
that any company can raise capital or
funds from two sources what could be
[297]
those sources one it can raise the fund
internal that means it can issue certain
[304]
common stock or it can issue certain
shares to the equity shareholders and
[309]
therefore it can raise money that is
called at internal source of funding
[313]
what is debt then debt is basically the
fund which the company has borrowed from
[318]
some external parties okay if the
company is not being able to meet its
[324]
cash flow requirements through its
internal fund what the company usually
[328]
do the company usually reach out to some
lenders and they can borrow the funds
[333]
and those funds can be long-term funds
as well as short-term funds that means
[338]
the company can borrow the debt for 1
year 3 year 5 years depending
[342]
upon the need so any fund that the
company has borrowed or has invested in
[348]
the company his car is can be classified
either as equity or debt and what we are
[354]
trying to compute over here we are
trying to compute return on invested
[359]
capital and when I am talking about
invested capital means what capital can
[364]
be invested from both the sources from
equity shareholders as well as from
[369]
external bodies right because both
amount has been invested in the company
[374]
even if I am raising some funds from
some lenders that amount also I am
[379]
investing in the company and therefore
when we are talking about invested
[383]
capital we consider both equity as well
as debt okay so net income -
[390]
dividend / equity + debt
will give us return on invested capital
[396]
let us try to understand this with the
help of an example
[401]
suppose the total sales revenue or the
total revenue of the company is say
[409]
$500,000 ok the total revenue of the
company is $500,000 the operating cost
[416]
of the company is $200,000 rate of tax
rate of tax is say 35% total equity of
[430]
the company is say 5 million dollars
and total debt of the company is say
[438]
3 million dollars okay so we have
equity funding as well as debt funding
[445]
in the car the question asked us the
question asked us to compute ROIC
[451]
what will be the ROIC of the company
and in order to compute the ROIC what
[456]
you will have to do first you will have
to compute net income how the net income
[460]
will be computed the net income is
nothing but revenue we have already
[466]
revenue given in the question which is
$500,000 out of this revenue I will
[473]
deduct the operating cost so that will
give me $200,000 so profit before tax
[484]
will be how much $500,000 - $200,000 out
of this I will reduce my taxes tax at
[493]
the rate of 35% 35% what my tax rate
over here so out of that I will reduce
[499]
taxes at the rate of 35% the net income
will be then how much $300,000 - $105000
[512]
which
means $195000
[516]
is my net income okay
there is no dividend given in the
[519]
question so the in it we need not reduce
dividend from this $195,000 what is
[526]
my invested capital as I mentioned
invested capital is how much equity +
[533]
debt 5 million dollars + 3 million dollars that means 8 million
[538]
dollars is my invested capital so how
much will be my ROIC ROIC will be $195000
[543]
/ 8 million dollars that means 2.44%
[548]
will be my
ROIC friends we have seen what does the
[553]
term return on invested capital means
and we have also computed we have also
[558]
seen how to compute return on invested
capital going back to our chart will
[565]
show the ROIC of Home Depot how do we
know that the ROIC of 25.89%
[572]
is good or passed
friends any ratio if you want to
[577]
interpret any ratio we need to interpret
that ratio with either an industry
[584]
average or we need to compare compare
that with the same ratio of some other
[590]
companies in the same industry any ratio
stand alone may not really make sense
[597]
why in this case Home Depot's return on
invested capital shows as 25.89%
[603]
the example
that we considered of any company that
[608]
show that ROIC of 2.44% does that mean that Home Depot
[614]
is performing much better than that
particular company may not be why
[618]
because each industry may have certain
limitations or restrictions in terms of
[624]
returns okay and therefore we need to
compare the ROIC of Home Depot with
[631]
the industry average of the same
companies or frame set of companies or we
[636]
need to compare the ROIC of Home Depot
with its key competitors and in that
[641]
case if we see that ROIC of Home Depot
is much better than its industry peers
[646]
in that case we can say that ROIC's of
Home Depot is much better than its peers
[653]
okay so this is all about return on
invested capital ratio
Most Recent Videos:
You can go back to the homepage right here: Homepage