Finding the Returns on Incremental Invested Capital

Return on incremental invested capital (ROIIC) is an extension of return on investment capital (ROIC), which is itself an extension of return on investment (ROI). Whereas ROI measures a company's profitability by dividing income by stock equity plus debt, ROIC tells investors how efficiently that profitability is earned per dollar of company capital. This ratio is expressed as a percentage.

ROIIC narrows the focus even further and shows how profitable each additional unit of capital investment could be. It is used in similar ways to the incremental capital output ratio.

A company uses its ROIIC to express the relationship between its capital investments and the rate of return on those investments.

How ROIIC Is Calculated

ROIIC is calculated by dividing a company's constant rate incremental operating income (plus depreciation and amortization) by the constant rate-weighted average-adjusted investment capital, according to the Securities and Exchange Commission (SEC). Note that the constant rate excludes the impact of foreign currency translation.

The denominator for the ROIIC equation needs to apply weights to each quarter in the time period being evaluated, which is usually one or three years. For example, in a one-year ROIIC, each of the four quarters must have a different exponent applied to adjust for differences in levels of investment activities. If more cash investments were made in Q3 than Q4, the weights should represent this.

The weighted results are then aggregated to produce a one-year adjusted cash figure. This should produce a more realistic reflection of how investments impact returns than a simple annual average. ROIIC can then be compared to the company's weighted average cost of capital (WACC) to help determine whether to pursue a new project.

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