1. Compute NOPAT
Take operating income (EBIT) and multiply by (1 − effective tax rate). This strips out financing, isolating operating returns.
How to calculate
How to calculate ROIC
To calculate ROIC (return on invested capital), divide NOPAT (net operating profit after tax) by invested capital. NOPAT is operating income (EBIT) times (1 minus the effective tax rate); invested capital is total debt plus shareholders' equity minus excess cash. The result is the after-tax return the business earns on the capital it actually employs.
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Short answer
ROIC = NOPAT / invested capital, where NOPAT = EBIT x (1 − tax rate) and invested capital = debt + equity − cash. Then compare it to WACC: ROIC only creates value when it beats the cost of capital.
Step by step
2. Compute invested capital
Total debt + shareholders' equity − cash and equivalents. (Equivalently: total assets − current liabilities − excess cash.)
3. Divide
ROIC = NOPAT / invested capital x 100. That's the after-tax return on the capital funding the business.
4. Compare to WACC
ROIC above the cost of capital creates value; below it destroys value. The spread is what actually compounds.
Worked example
A company has $1.0B of EBIT and a 25% tax rate, so NOPAT = 1,000 x (1 − 0.25) = $750M. Its invested capital is $2B debt + $3B equity − $0.5B cash = $4.5B.
ROIC = 750 / 4,500 x 100 = 16.7 percent. Against a 9 percent WACC, that's a 7.7-point spread: the business earns well above what its capital costs, so reinvested earnings compound intrinsic value. If ROIC were 7 percent, below the 9 percent WACC, growth would be destroying value despite a positive profit.
ROIC calculator
Enter operating profit, the tax rate, and the capital figures.
Result-
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Related
- What is ROIC? - the concept and why it beats ROE as a quality gauge.
- What is a good ROIC? - the benchmark ranges once you've calculated it.
- What is WACC? - the hurdle rate ROIC must clear to create value.
See ROIC vs the cost of capital
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Educational only. invest-like is not a registered investment adviser; nothing here is personalised investment advice. Always do your own research and consider your individual circumstances.