Return on capital

The proflt-to-investmentratio (PIR) may be defined in many ways, and is most meaningful when deflated and discounted. On an undeflated and undiscounted basis, the PIR may be defined as the ratio of the cumulative cash surplus to the capital investment. This indicates the return on capital investment of the project, is simple to calculate, but does not reflect the timing of the income/investment in the project. 

The most common approach to fixed cost estimation iavolves the use of a capital recovery factor to give the annual depreciation and return on capital. This factor typically is between 15 and 20% of the total capital investment. Property taxes are taken as 1—5% of the fixed capital and iasurance is assumed to be 1—2% of the fixed capital. If annual depreciation is estimated separately, it is assumed to be about 10% of the fixed capital investment. The annual iaterest expense is sometimes neglected as an expense ia preliminary studies. Some economists even beHeve that iaterest should be treated as a return on capital and not as part of the manufactufing expense. 

Research and development ac tivities do not, in themselves, produce a salable product. Thus, they cannot direc tly generate a return on capital outlay. A successbil research and development projec t is one that results in an activity that earns revenue for the company. The life cycle of the revenue from an individual product may be as shown in Fig. 9-26. 

The percentage markup on cost is calculated for a known capital-turnover ratio and a desired rate of return on capital. As with absorption pricing, the percentage markup on manufac turing cost per unit of prodlic tion is calculated for a normal annual produc tion rate. If this produc tion rate is exceeded, the rate of return on capital will be higher than projected because of the decrease in unit cost. Conversely, if the... 

Eroduc tion rate is lower than normal, the rate of return on capital will e lower than projected because of the increase in unit cost. For production rates both higher and lower than the normal produc tion rate, the percentage markup is based on the normal unit cost. Thus the method is strictly vahd only for the normal production rate. 

The return on capital investment did not justify a power recovery system unless more tlian several tliousand horsepower was recovered. 

Recently, there has been a substantial shift in conditions and user attitudes. With increasing cost of power, the return on capital investment has vastly improved. A more favorable regulatory climate and changes in attimde of utility companies toward remrning electricity to tlieh grid have made novel power producing schemes practical and attractive. 

At the enterprise level, the executive management responds to the voice of ownership and is primarily concerned with profit, return on capital employed, market share, etc. At the business level, the managers are concerned with products and services and hence respond to the voice of the customer. At the operational level, the middle managers, supervisors, operators, etc. focus on processes that produce products and services and hence respond to the voice of the processes carried out within their own function. 

Any presentation to the organization s senior management, besides giving the technical details, should include a financial appraisal, which could be on a simple payback basis. However, other methods are available, such as return on capital employed and discounted cash flow (DCF). 

Return on capital employed can be expressed in four ways ... 

Ratios well below 1 may indicate financial problems ahead while those substantially greater than 1 may point to poor credit control or under-utilization of cash. This ratio is sometimes known as the acid test . The principal profitability ratio in use is the net profit before interest and tax (NPBIT) to net assets or return on capital employed. 

The most widely used gage of profitability is the ratio of profit to net assets (or return on capital employed) ... 

Return on capital Profit/Sales Sales/Net assets... 

The chemical and petrochemical industries are highly capital intensive and this has two important implications for the plant designer. Before the expenditure for any plant is approved, a discounted cash flow (DCF) return on capital invested is projected (Section 9.1). The capital cost of the plant is a key factor in deciding whether the DCF return is above or below the cut-off value used by a company to judge the viability of projects. Thus, there is always strong pressure on the materials engineer not to overspecify the materials of construction. 

Most of the increase in the estimate from applying advanced technology comes from improvements in chemical flooding methods. The projections assume that crude oil has a nominal price of 30 per barrel and that the minimum rate of return on capital is 10 percent. Reprinted with permission from Enhanced Oil Recovery. Copyright 1984 by the National Petroleum Council. 

Borrell s study43 attempts to measure the effect of price control in the UK, which is based on limiting the rate of return on capital. Using cointegration techniques, the author concludes that the system has had little effect in terms of price containment. 

The EVA [10,11] combines information from the profit and loss statement (revenue, costs, earnings before interests and taxes (EBIT), etc.) and the financial sheet (net working capital (NWC), assets, etc.). The EVA is the interest calculation in absolute measurements and strongly related to the return on capital employed (ROCE) where the gained interest rate is calculated (Figure 1.7). In the long term, this interest rate should be above the capital costs of the company which is the interest rate the company has to pay for a credit on the capital market. Hence, a positive EVA means that the company has earned some money above the capital costs. 

Value-oriented management concepts evolved from cost and profit controlling towards value based management concepts. Transparency on profitability of invested capital for the company and its shareholders is an objective of value-based management. Profitability indicators are related to capital indicators. Common indicators are Return on Assets (ROA), Return on Capital Employed (ROCE) and Economic Value Added (EVA ) as presented in table 3 (Hostettler 2002 Revsine et al. 2004). 

For this study, an economic hurdle rate of 15 % before tax return on capital investment was used. This rate is higher than for the flake feed preparation facility because the depolymerization facilities cannot be as easily converted to other uses as can the flake preparation plants, which can be converted to produce mechanically cleaned PET for traditional post-consumer PET uses. Including the total capital return component, and a 12 year economic depreciation component, the total cost of the products are given in Table 16.4 as US 1.07/kg to US 1.32/kg. 

The reasonableness of the maximum return on capital (ROC) earned by individual companies on home sales of NHS medicines is a matter for negotiation within a published range of 17% for level 1 and 21 % for level 2, having regard to the nature and scale of the company s relevant investment and activities, and associated long-term risks. 

The allowable returns on capital will be associated with a margin of tolerance (MOT). Companies wiU be able to retain profits of up to 140% of the level 2 (21 %) ROC target calculated by reference to level 2 allowances. Companies will not be granted price increases unless they are forecasting profits less than 50% of their level 1 (17%) ROC target calculated by reference to the level 1 allowances. 

A number of non-UK European-based companies have criticised the rate of return on capital (ROC) on the basis that it favours companies with a large capital base in the United Kingdom and could therefore be regarded as an incentive to invest in the United Kingdom, which is contrary to European Union legislation. 

The same group of companies have regarded the PPRS as discriminatory, as companies with a significant capital investment in the United Kingdom have their profits determined as return on capital base, whereas others that have a large investment in the European Union as a whole may operate in the United Kingdom as sales companies only. In this situation, these companies are treated on a percentage profit on sales, which are less favourable terms. 

Return on investment (ROl), Return on Capital Employed (ROCE) and Internal Rate of Return (IRR) are terms all referring to the profitability of a project or product in terms of the original investment made, i.e. ... 

Compare estimates of pay-back time and return on capital invested as estimates of a product s profitability. 

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