What is ROIC?

CFA Level II Equities
#1

I am very frustrated with the lack of clear guidance on this. The internet has multiple definitions for the calculation of ROIC. Some subtract cash, some don’t…some use NI - dividends, some use NOPLAT. My study guide and the paragraph in CFAI says that ROIC is NOPLAT/Operating Assets - Operating Liabilities, which is Net Operating Assets (correct me if I’m wrong). Which would pretty much mean that Invested capital in this case is ignoring long term debt and assets. However, the footnote in the CFAI curriculum it says that it is operating assets - operating liabilities + net fixed assets.

If they ask for ROIC how exactly am I supposed to know which definition to use?

#2

It’s NOPLAT / IC

IC = OA-OL

In other words, only the assets that were used to generate the NOPLAT, and all the current (operating) liabilities are subtracted from them.

Net fixed assets are part of OA.

#3

This will be one I will be skipping and coming back to at the end.

you need to include deferred taxes, IFRS/GAAP considerations (e.g. contingent assets), what is actually an operating asset (machine spare parts?). unlevering NI … a whole crap shoot really.

very hard one to get right in 3mins.

#4

Investment capital = long/short term debt + equity

ROIC = EBIT(1-t) / (debt+equity)

#5

Not really, no.

Or not always at least.

#6

No

#7

Yes

#8

ROIC= NOPAT / IC

IC=common + debt + Preferred

NOPAT= EBIT(1-T)

EVA= NOPAT- IC*WACC

#9

This thread is a perfect example of why I’m so frustrated lol.

So the most common answer is that IC is OA - OL, without adding net fixed assets? What exactly does an operating asset or liability consist of?

#10

which page is this on?

#11

Join the club. I thought it was quite clear in my head before I starting reading this thread!

#12

OA = Total assets - non-operating assets !

It’s actually quite easy. Non-operating assets are the things you can dispose of in the balance sheet without affect your operating income on the income statement. Like pensions, excess cash, property available for sale, anything that does not produce a cash flow, or indirectly affects cash flows from operation is a non-operating asset.

#13

Is that in the Residual Income Valuation reading?

#14

Once future income statements and balance sheets are constructed, analysts can use them to determine the rate of return on invested capital (ROIC) implied by their assumptions. ROIC measures the profitability of the capital invested by the company’s shareholders and debt holders. The numerator for ROIC is usually net operating profit less adjusted taxes (NOPLAT). NOPLAT is basically earnings before interest expense (i.e., earnings available to provide a return to both equity holders and debt holders). The denominator for ROIC is invested capital, which is calculated as operating assets less operating liabilities.4

(Institute 76)

Institute, CFA. 2015 CFA Level II Volume 4 Equity. Wiley Global Finance, 2014-07-14. VitalBook file.

The footnote 4 states that Hawawini and Viallet define invested capital in detail as cash and cash equivelants plus working capital requirement (which is OA - OL) plus net fixed assets.

So…I’m just gonna go with MrSmart’s definition because it meshes with the curriculum paragraph, and I guess I’ll just ignore the footnote.

#15

I think they meant cash + working capital requirment (CA-CL) + net fixed assets.

Note that WC+FC = OA

Generally, we do not include excess cash in the calculation of IC, since it’s not included in NOPLAT either.

#16

Ok. This makes more sense now.

#17

why else would you issue debt or equity?

this is effectively trying to measure NWC +Fixed capital

i guess if you are doing a levered recap…you borrow money to pay dividends. but then again…its a wash at first. Cash in, cash out…but you’ll be hit with interest.

#18

If you look at it from a project finance poin of view. total captial = debt + equity.

#19

Note:

I’m going through Wiley at the moment, and it states that IC includes cash and investments.

Even though I don’t agree with this, do what the CFAI book tells you.

We are assuming here that there is no excess cash.

For practical purposes (not exam related), excess cash beyond that of operating needs are removed.