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Finance

What is Return on Invested Capital?

By Alexis W.
Updated May 17, 2024
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The return on invested capital is the amount of money an investor earns for a given investment. The return on invested capital, or return on investment as it is often called, allows investors to determine how much they make on a given investment. It is a useful tool to measure whether an investment is a good investment or a bad investment.

Capital refers to the amount of money an individual invests in a given investment source. For example, an individual could invest $100 US Dollars (USD) to purchase a stock. In this case, the return on invested capital would refer to the amount of money the investor makes in relation to the original $100 USD investment.

The return on invested capital is a useful measure to determine whether an investment is a good one or not. It can also be used to compare different investments, by comparing the return on the investment. For example, if one investment has a higher return on investment than another, the company with the higher rate of return is the better investment, assuming all other variables such as riskiness of the investment are the same.

To calculate the return on investment, the money invested must be compared to the money made. For example, if a $100 USD investment earns $50 USD, this rate of return is a better rate of return than if a $500 USD investment returns $50 USD. Thus, this allows investors to compare the performance of different investments when the investor puts a different amount of money into each respective investment.

Calculating the return on investment is simple. The cost of the investment is subtracted from the gain on the investment and that number is divided by the cost of the investment. For example, assume an investor purchased $100 USD worth of stock and made $50 USD on his investment. The return on investment would be equal to $150 USD - $100 USD / $100 USD, or a 50 percent return on invested capital.

This ratio can be used when evaluating stock purchases or when comparing the performance of respective products. If a product cost $100 USD to make and the profit on the product was $150 USD, the same return on investment calculation described above could be used to determine which product was a better investment, and thus which product was a better producer for the company. Because of the simplicity of the equation, performing this type of equation is common in business and investing applications.

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