Question

Samsco has current after-tax operating income of $65 million and a cost of capital of 9.5%. Assume that the firm is in stable growth, growing 3% a year forever and that the reinvestment rate is 35%. What is the return on invested capital

Answer 1

10%

Step-by-step explanation:

Return on Invested Capital = After-tax operating income / Invested capital

After-tax operating income = 65,000,000

Invested capital = ?

Invested capital = After-tax operating income * (1 - Reinvestment rate ) / (Cost of capital - Expected growth rate)

After-tax operating income = 65,000,000

Reinvestment rate = 35%

Cost of capital = 9.5%

Expected growth rate= 3.0%

Invested capital = 65,000,000 * (1 - 35%) / (9.5% - 3%)

Invested capital = 65,000,000 * 65% / 6.5%

Invested capital = $650,000,000

Hence, Return on Invested Capital = $65,000,000 / $650,000,000

Return on Invested Capital = 0.10

Return on Invested Capital = 10%