DEFINITION of 'Economic Spread'

The term economic spread is a performance metric that is equal to the difference between a company's weighted average cost of capital (WACC) and its return on invested capital (ROIC).

The term can be used to measure the difference between the real rate of return on an investment and the rate of inflation in the economy.

BREAKING DOWN 'Economic Spread'

An economic spread is a measure of a company's ability to make money on its capital investments. Simply put, if the cost of capital exceeds the return on invested capital, the company is losing money: what the company is doing with the capital is not providing enough to cover the cost of borrowing or using it. This could be down to inefficiencies or merely a poor investment. 

Some financial pundits refer to economic spread as market value added because the spread is a representation of a company's value from an operations standpoint. 

Pension Plans

The term is important for evaluating the returns of a pension plan. The value of its invested funds may be increasing at what seems to be an acceptable level, but if the invested capital is not growing at a rate above inflation, the investment is losing its value on an annual basis. This nominal loss results from the fact that the invested capital will not be able to buy as much for the investor in the future as it can at the present time.

A company with a high economic spread is a sign of efficiency and good overall performance. On the contrary, a company can have a negative economic spread, which can be a sign of stress on its assets and can often mean the assets are outdated or overextended. 

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