Question

A firm has $100,000 in Net Income. Its invested capital is $500. The firm’s interest rate is 4% and tax rate is 25%. What is its ROIC?

Answer 1

For return on invested capital, we need to calculate earnings before taxes, interest expense and net operating profit after taxes.

First we will calculate Earnings before tax as below:

Net income = Earnings before tax * (1 - tax rate)

Putting the given values in the above formula, we get,

$100000 = Earnings before tax * (1 - 25%)

Earnings before tax = $100000 / 75% = $133333.333

Next, we will calculate interest expense as below:

Interest expense = Invested capital * Interest rate

Interest expense = $500 * 4% = $20

Next, we will calculate Net operating profit after tax as per below:

Net operating profit after tax = (Earnings before taxes + Interest expense) * (1 - tax rate)

Putting the values in the above formula, we get,

Net operating profit after tax = ($133333.333 + $20) * (1- 25%)

Net operating profit after tax = $133353.33 * 75% = $100015

Now, we will calculate Return on invested capital as per below:

Return on invested capital (ROIC) = Net operating profit after tax / Invested capital

Putting the values in the above formula, we get,

Return on invested capital (ROIC) = $100015 / $500 = 200.03