In short
Return on investment for a division or investment center is operating income divided by average invested capital (operating assets). It equals profit margin multiplied by asset turnover.
Key takeaways
- Managers judged on it may reject projects that earn more than the cost of capital but less than their current return.
- Residual income avoids that problem by measuring income above a required return.
- Using net book value of assets can make older divisions look better.
Example
Operating income of $150,000 on average invested capital of $1,000,000: return on investment is 15% (margin 10% × turnover 1.5 on $1,500,000 of sales).
Where it's tested
BAR: Financial Statement Analysis — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
A company with a current ratio of 0.8 uses cash to pay off an accounts payable balance. What is the effect on the current ratio?