I’ve got a quick accounting question I was hoping you guys could help me with. I’m trying to calculate Return on Capital Employed for a company. But, more importantly, I’m trying to figure out how Price-to-Book-Value interacts with ROCE.
Here’s a quick hypothetical example:
Return on Capital Employed = (Operating Income)/(Capital Employed)
Assuming Operating Income = $100
Assuming Capital Employed = $950
Return on Capital Employed = 10.52%
This ROCE is for the value of the capital employed by the company but not necessarily by an investor. That is, the cost of purchasing the company’s “capital employed” today is dictated by the stock price, which leads me to believe I should also be considering the price-to-book-value when looking at ROCE. For example, if the P/B value was 1.5 I would be spending 1.5 times the value of the “capital employed” to receive the same operating income which drives down the return:
Assuming Operating Income = $100
Assuming Capital Employed = $950
Assuming P/B = 1.5
Return on capital employed to someone buying the stock = (100)/(950 x 1.5) = 7.01%
Alternatively:
Assuming P/B = 0.8
Return on capital employed to someone buying the stock = (100)/(950 x 0.8) = 13.16%
Is this wrong? I’ve been toying with the idea for a bit and I think it’s right but my accounting knowledge is pretty limited. Now, I realize that “capital employed” and “book value” are not the same, but I figure they’re closely related in this context. The amount of leverage within the company would also affect this. But assuming that the capital structure is 100% equity would this make sense?
Thanks!
Submitted November 11, 2017 at 01:59PM by ROCEAccountingQ http://ift.tt/2ACUsTQ
