What is 'Return On RiskAdjusted Capital  RORAC'
The return on riskadjusted capital (RORAC) is a rate of return measure commonly used in financial analysis, where various projects, endeavors and investments are evaluated based on capital at risk. Projects with different risk profiles are easier to compare with each other once their individual RORAC values have been calculated.
BREAKING DOWN 'Return On RiskAdjusted Capital  RORAC'
Allocated risk capital is the firm's capital, adjusted for a maximum potential loss based on estimated future earnings distributions or the volatility of earnings. Companies use RORAC to place greater emphasis on firmwide risk management. For example, different corporate divisions with unique managers can use RORAC to quantify and maintain acceptable riskexposure levels. This calculation is similar to riskadjusted return on capital (RAROC). With RORAC, however, the capital is adjusted for risk, not the rate of return. RORAC is used when the risk varies depending on the capital asset being analyzed.
Example Calculation
The RORAC formula is straightforward. To calculate RORAC, take the net income of the project or firm and divide it by riskweighted assets. For example, assume a firm is evaluating two projects it has engaged in over the previous year and needs to decide which one to eliminate. Project A had total revenues of $100,000 and total expenses of $50,000. The total riskweighted assets involved in the project is $400,000. Project B had total revenues of $200,000 and total expenses of $100,000. The total riskweighted assets involved in Project B is $900,000. The RORACs are calculated as:
Project A RORAC = ($100,000  $50,000) ÷ $400,000 = 12.5%
Project B RORAC = ($200,000  $100,000) ÷ $900,000 = 11.1%
Even though Project B had twice as much revenue as Project A, once the riskweighted capital of the projects are taken into account, it is clear that Project A has a better RORAC.
RORAC is similar to, and easily confused with, two other statistics. Riskadjusted return on capital (RAROC) is usually defined as the ratio of riskadjusted return to economic capital. In this calculation, instead of adjusting the risk of the capital itself, it is the risk of the return that is quantified and measured. Often, the expected return of a project is divided by value at risk to arrive at RAROC. Another statistic similar to RORAC is the riskadjusted return on riskadjusted capital (RARORAC). This statistic is calculated by taking the riskadjusted return and dividing it by economic capital, adjusting for diversification benefits. It uses guidelines defined by the international risk standards covered in Basel II.

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