Return on Capital Employed - What is return on capital

You have explained Return on net worth in the previous session . How does it differ from Return on capital employed and why do we use both numbers generally. Also how is it different from IRR ( Internal rate of Return ) ??? Why in Dominos Balance Sheet the Net worth is less than the Share Capital ( I have understood it is Assets minus Liabilities ) Can you explain why it has gone down ???

1 Answer(s)


Return on net worth or Return on Equity is amount of net income or profit after tax divided by the shareholders equity. It indicates how efficiently the shareholders capital is being deployed.

Return on Capital Employed is Net Income divided by Equity + Debt employed. So the difference between ROE and ROCE is that ROE factors in only the Equity Capital bur ROCE factors in debt also. So a debt laden company's ROCE will be lesser then ROE due to a higher denominator in ROCE.

While ROE and ROCE are used to measure how optimally capital is being deployed, IRR is used to measure the feasibility of projects or in other words the returns from a project. ROE and ROCE only take into account the Net Income and net income does not take into account Capex expenses like new machinery etc. IRR is calculated using a company's FCF (Free Cash Flow - explained in later modules) and hence is a better representation of the actual returns from a project.

Now, Networth = Assets - Liabilities. It is also = Share Capital + Reserves - any carryforward losses from P&L. Basically this means that the share capital is reduced by previous years loses or increases by profits in order to get to net worth. In Dominos case, since it was previous years loses (page 12 of the net worth is lesser than the share capital.