Returns on Capital

The cost of capital and related returns on capital produce results that can be either accretive or depletive for investors.  Given the complexity of the issue I will stick to a relatively simple definition of capital, and then provide a few additional calculations for much more complex and detail oriented analysts to decide which to use for their formula of returns on capital.  In general, returns on capital in excess of firm specific capital costs, result in excess returns for shareholders.  These returns are used to either grow the business or distribute to shareholders through cash dividends or stock dividends. 

Capital - Financial Assets or financial resources available for use

The following calculations are general formulas for calculating return on capital:

Return on Capital:
EBIT (1- Effective Tax) / Capital

Capital 1:
Book Value Debt + Book Value Equity - Cash
also referred to as Enterprise Value

Capital 2 (Operating Approach):
Net Working Capital + Net Property Plant Equipment + Capitalized Operating Leases + Other Operating Assets + Operating Intangibles - Other Operating Liabilities - Cumulative Adjustment for R&D

Capital 3 (Financing Approach):
Total Debt + Total Leases + Equity and Equivalents - Non-Cash Investments

When attempting to assess the value creation of a firm, take the return on capital, which represents the amount of after-tax operating income that the firm generates, and compare that figure to the firms weighted average cost of capital.  Any returns on excess of the cost of capital is creating value for shareholders.  In order to identify whether any investment opportunity is cheap or not, compare that figure to the price multiples in order to gauge whether or not the additional value accretion is cheap or not.