Return on Capital

Return on capital (ROC) is defined as a measure of how effectively a company uses the money, whether borrowed or owned, invested in its operations. Return on capital is a ratio which is used in finance, valuation, and accounting. ROC is an amount of return from any investment where that return is not considered to constitute profit or income. ROC is usually the original amount of financial resources that were initially invested in some type of business or investing venture, but not any type of profits that were generated as a result of the investment. Return on capital is calculated as dividing the after-tax operating income (NOPAT) by the book value of invested capital.

Return on capital is different from return on invested capital (ROIC) which is a financial measure that quantifies how well a company generates cash flow relative to the capital it has invested in its business. ROIC is calculated as net operating profit less adjusted taxes divided by invested capital and is usually expressed as a percentage. The capital invested includes all monetary capital invested i.e. long-term debt, common and preferred shares.

A return of capital does not have to include the full return of the original investment. Depending upon the trusts of different types may choose to return part of the initial investment to their investors, while still retaining a portion of that investment. This leads to a situation where the investor will receive less of a return on capital in the future, since the amount invested in the venture is reduced.

According to the investment types and the tax codes that apply to investing, it is highly unlikely that a return of capital will result in the creation of tax debt for the investor. This is because the taxes had already been assessed on the funds used to make the initial investment. Therefore there would be no need to assess taxes again, since the investor had not earned any type of profit from that return of capital.

Questions:

• What is return on capital?
• How is return on capital different from return on invested capital?