Corporate and Project Finance Modeling

Chapter 25Calculation of Invested Capital

The invested capital calculation used for computing the return on invested capital (ROIC) involves dissecting the balance sheet into different categories. The idea is to identify items that are related to generating earnings before interest, taxes, depreciation, and amortization (EBITDA) such as working capital and net plant and equipment. These items should be distinguished from items that produce income and expenses other than EBITDA such as financial investments in bonds that generate interest income. It may seem mundane and relatively simple to establish asset and liability items that should be included in the invested capital using the guiding principle as to whether the balance sheet items are involved in producing EBITDA. However, when dealing with actual balance sheets, the process can be quite tricky. The next two chapters are devoted to this subject because understanding what assets or liabilities are associated with the operating and EBITDA side of a business rather than the financing part of a company provides the foundation for many valuation and financial modeling subjects. Three specific benefits from carefully segregating the balance sheet include:

1. Once balance sheet items are identified and segregated on the basis of those that lead to the generation of EBITDA for purposes of computing invested capital, the same segregation process can be used to evaluate the difference between equity value and enterprise value. This ...