Return on capital against its cost: ROIC and WACC in plain words
A business creates value only when it earns more on its capital than that capital costs. How to calculate both sides, and why growth can destroy value.
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Key takeaways
- A business creates value only when the return it earns on the money invested in it is higher than the return its lenders and owners could expect elsewhere for the same risk.
- Common mistakes: Saying a project is good because it is profitable, without comparing its return with the cost of capital.
- Cost of debt: the interest rate on borrowing. Interest lowers taxable profit, so the real cost is the rate times (1 minus the tax rate).
- Cost of equity: the return shareholders expect for the risk they carry.
- Equity costs more than debt, because owners are paid last and carry more risk.
Key idea
A business creates value only when the return it earns on the money invested in it is higher than the return its lenders and owners could expect elsewhere for the same risk. Profit alone is not enough; profit must beat the cost of the capital.
Return on invested capital (ROIC) is NOPAT divided by invested capital. Invested capital is the money tied up in running the business: fixed assets plus operating working capital. Seen from the other side of the balance sheet, it is the money lenders and owners put in, minus spare cash. The cost of capital is usually measured as the weighted average cost of capital (WACC): the after-tax cost of debt and the cost of equity, weighted by how much of each the company uses.
The two costs, in plain words
- Cost of debt: the interest rate on borrowing. Interest lowers taxable profit, so the real cost is the rate times (1 minus the tax rate).
- Cost of equity: the return shareholders expect for the risk they carry. Nobody sends a bill for it, but it is a real cost: if the company does not earn it, the share price falls and new money becomes hard to raise. It is an opportunity cost, the return owners give up by not investing elsewhere.
- Equity costs more than debt, because owners are paid last and carry more risk.
Worked case
Does a cement plant expansion create value?
The prompt
A cement producer in the UAE (fictional, AED millions) earns EBIT of 150 on invested capital of 1,000. Tax is 20 percent (illustrative). It is funded 60 percent by equity, which costs 12 percent, and 40 percent by debt at 6 percent before tax. Management wants to invest another 500 in a new line expected to earn a return of 7 percent after tax. Does the company create value today, and would the expansion add to it?
The structure
- Value created each year = (ROIC minus WACC) x invested capital (this comes from the question: does the return beat the cost?)
- ROIC today: NOPAT divided by invested capital
- WACC: the weighted after-tax cost of debt and cost of equity
- Value created today, and by the expansion
Working it through
1. NOPAT
EBIT 150 after 20 percent tax.
NOPAT (AED millions):150 × 0.8 = 1202. ROIC
NOPAT divided by invested capital of 1,000.
ROIC (percent):120 ÷ 1,000 × 100 = 123. After-tax cost of debt
Interest of 6 percent, less the 20 percent tax saving.
After-tax cost of debt (percent):6 × (1 - 0.2) = 4.84. WACC
60 percent at 12, plus 40 percent at 4.8.
WACC (percent):0.6 × 12 + 0.4 × 4.8 = 9.125. Value created today
The spread of 12 minus 9.12 on capital of 1,000. This is often called economic profit.
Economic profit today (AED millions):(12 - 9.12) ÷ 100 × 1,000 = 28.86. The expansion
A return of 7 percent on 500, against a cost of 9.12 percent.
Economic profit of the expansion (AED millions):(7 - 9.12) ÷ 100 × 500 = -10.6
The recommendation
The company creates value today, but the expansion as planned would destroy it. Today it earns a 12 percent return against a cost of capital of about 9.1 percent, which is about AED 29 million a year of value above the cost. The new line would earn 7 percent on 500 million, below its cost, which means about AED 10.6 million a year of value lost even though it adds profit. The risk in the analysis is the 7 percent estimate itself: a higher cement price could lift it. As a next step, find what price or cost level would take the new line above 9.1 percent before approving it.
Risks: The cost of equity is an estimate, not a bill, so test a range; A cement price change moves both returns.
Bar chart: Average cost of capital by industry, US companies, January 2026. Values in percent. Utilities (general): 4.36; Telecom services: 5.39; Air transport: 6.72; Apparel: 7.13; Retail (general): 7.27; All US companies except financial firms: 7.72; Pharmaceuticals: 7.85; Software: 9.34; Cars and trucks: 9.38.
Source: NYU Stern School of Business, Damodaran Online, cost of capital by industry (US), data as of January 2026, checked 2026-10-01. US dollar figures.
So-what
Most large US companies need roughly 5 to 10 percent a year. Stable, regulated businesses sit at the bottom; riskier, more cyclical ones at the top. These are US dollar figures: in countries with higher interest rates and inflation, the cost of capital in local currency is higher.
Companies define return measures in their own way, so read the definition before you compare. Inditex reported a return on capital employed of 40 percent for FY2025, but it defines this as profit before tax divided by average equity, because it has no net debt. That is a pre-tax measure and is not the same as ROIC after tax.
A company is funded 70 percent by equity that costs 10 percent, and 30 percent by debt at 5 percent before tax. Tax is 25 percent. What is its WACC, in percent?
A logistics firm in Singapore has NOPAT of SGD 45 million and invested capital of SGD 300 million. Its WACC is 8 percent. What is its ROIC, in percent?
Saying a project is good because it is profitable, without comparing its return with the cost of capital. Comparing a return in one currency with a cost of capital in another. Forgetting goodwill: after an acquisition, the price paid sits in invested capital, so ROIC including goodwill shows whether the deal paid off. Assuming growth always helps: growth at a return below the cost of capital makes the company bigger and its owners poorer.
A company earns a 6 percent return on capital and its cost of capital is 9 percent. It doubles in size at the same return. What happens to value?
Why is the after-tax cost of debt lower than the interest rate?
Facts checked against sources on 2026-10-01. Sources, company filings and standard setters first.
- NYU Stern School of Business, Damodaran Online data: cost of capital by industry (US), data as of January 2026: https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/wacc.html
- Inditex: FY2025 Results (1 February 2025 to 31 January 2026), results release with consolidated income statement, balance sheet and cash flow statement: https://www.inditex.com/itxcomweb/api/media/1da2c9d1-dbca-49fb-9563-982a8a27fae6/INDITEXFullYear2025.pdf
Sources for this lesson (3)
- Recognized public explanations of case-interview concepts and terms
- NYU Stern School of Business, Damodaran Online data: cost of capital by industry (US), data as of January 2026
- Inditex: FY2025 Results (1 February 2025 to 31 January 2026), results release with consolidated income statement, balance sheet and cash flow statement
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