Check whether a plant expansion earns its cost
Return on invested capital (ROIC) · Fictional case
The situation
A manufacturer has expanded its plant to win larger orders. The new line is profitable, and the plant manager wants to build a second one.
The finance director asks whether the return covers what the company pays to tie up that much money. Evaluate the current year and say what else the board would need.
- Operating profit before tax
- ₹18 crore
- Average capital invested
- ₹150 crore
- Tax rate / cost of capital
- 25% / 10%
Full data and assumptions
A project adds ₹18 crore of operating profit before tax on ₹150 crore of average invested capital. Assume a 25% tax rate and a 10% cost of capital.
Your task
Does the project earn its cost of capital in this year?
Reveal step-by-step solution
Set up the problem
After-tax operating profit is ₹18 × 75% = ₹13.5 crore.
Work through the numbers
ROIC is ₹13.5 ÷ ₹150 = 9%. The cost of capital in rupees is ₹150 × 10% = ₹15 crore.
Interpret the result
The project falls ₹1.5 crore short of its capital charge this year. Forecast the rest of its life before making an investment decision.
What to remember
Compare operating profit after tax and operating capital using a consistent scope.