Question

JetCo is a manufacturer of high speed aircraft. The company generates $100 million in operating profit on $600 million of revenue and $800 million of invested capital. JetCo’s primary competitor Gulf Aviation also generates $100 million in NOPLAT. Gulf Aviation is slightly larger; the company recorded $800 million in revenue. Gulf Aviation has $600 million in invested capital. Using the industry data presented in Question , decompose ROIC into operating margin and capital turnover for each company. Which ratio is more important in determining ROIC, operating margin or capital turnover?

Answer 1

ROIC = Return in Invested Capital i.e. how much profit you are earning by investing the capital

Operating Margin = Operating Profit earned in respect of sale revenue

Capital Turnover = Turnover company is generating in respect of Capital Invested

Jet Co. = ROIC = (operating Profit/ Invested Capital) * 100 = (100 / 800) *100  = 12.50 %

Decompose into Operating Margin and Capital Turnover

Operating Margin = (100 / 600) *100 = 16.67 %

Capital Turnover = (600/800) *100 = 75 %  

Return on Invested Capital =Operating Margin * Capital Turnover = 16.67 % * 75 % = 12.50 %

Gulf Aviation Co. = ROIC = (operating Profit/ Invested Capital) * 100 = (100 / 600) *100  = 16.67 %

Decompose into Operating Margin and Capital Turnover

Operating Margin = 100 / 800 *100 = 12.50 %

Capital Turnover = 800/600 = 133.33 %  

Return on Invested Capital =Operating Margin * Capital Turnover = 12.50% * 133.33 % = 16.67 %

In determine Return on Invested Capital, Both ratios Operating Margin and Capital Turnover are important, but majorly Operating Profit play a vital role in this Ratio so in that respect I would like to say operating Margin ratio is more important.