###### Fundamental Determinants of Residual I ...

The fundamental drivers of residual income can be recognized by assuming a... **Read More**

* Return on invested capital* (ROIC) measures the profitability of the capital invested by the company’s shareholders and debt holders.

$$\text{ROIC}=\frac{\text{Net operating profit less adjusted taxes (NOPLAT)}}{\text{Invested capital}}$$

NOPLAT is earnings before interest expense which is earnings available to equity holders and debt holders. The invested capital is calculated as operating assets less operating liabilities.

ROIC is a better measure of profitability relative to return on equity because it is not affected by a company’s degree of financial leverage. Sustainably high ROIC is a sign of competitive advantage. To increase ROIC, a company must either increase earnings, reduce invested capital, or both.

* Return on capital employed* (ROCE) is operating profit divided by capital employed (debt and equity capital). ROCE can be used to compare companies with different tax structures.

$$\text{ROCE}=\frac{\text{Operating profit}}{\text{Capital employed (debt and equity capital)}}$$

## Question

Which of the following is the return

most likelyto be used to evaluate companies in different tax jurisdictions?

- Return on capital employed.
- Return on invested capital.
- Net operating profit less adjusted taxes.
## Solution

The correct answer is A.Return on capital employed is a profitability measure that is used to compare companies with different tax structures. It uses pre-tax measures to calculate return.

B is incorrect.Return on invested capital measures the profitability of capital invested by a company’s shareholders and debt holders. The numerator in the return on capital invested is tax adjusted.

C is incorrect.Net operating profit less adjusted is a financial metric that calculates a firm’s operating profits after adjusting for taxes.

Reading 22: Industry and Company Analysis

*LOS 22 (f) D**escribe the relationship between return on invested capital and competitive advantage.*