Two shops in the same market each earn ₹30 lakh of profit a year. Shop A needed ₹1 crore of capital to set up: fittings, inventory, deposits. Shop B needed ₹3 crore for the same profit. Nobody hesitates. Shop A is the better business. It earns 30% on its capital and Shop B earns 10%. If both reinvest their profits into new shops of the same kind, A compounds three times as fast. Or A's owner can pull two-thirds of the profit out every year and still grow as fast as B.
That ratio, profit per unit of capital tied up, is what a fixed deposit quotes you up front as an interest rate. A business never quotes it. You have to compute it yourself, and both ingredients are slippery:
- Which profit? Reported net income belongs to shareholders after interest. It's also polluted by non-operating income, such as interest earned on the cash pile or one-time gains, and by one-offs. You want the profit the operating business itself generates, however it happens to be financed.
- Which capital? Total assets is too big. It includes the treasury's idle cash and double-counts things suppliers are financing for free. Shareholders' equity is too small, and it mixes in financing choices: a company that borrows heavily shows tiny equity and a flattering ROE.
Advertisement
How is return on invested capital calculated?
Get both right and you have ROIC = NOPAT ÷ Invested Capital, which is after-tax operating profit divided by the capital actually tied up in operations. Judge it against the cost of that capital. That's WACC, and you'll build it properly in the cost of capital module. Until then, use ~12% post-tax for India and ~8–9% for the US as rules of thumb (as of mid-2026, check when you build real WACCs). That answers question 2 of the five: is this a good business? Value is created only when ROIC exceeds WACC and the company can reinvest at that spread. Everything else in the build is machinery for measuring that spread fairly.
A naming note before you start. McKinsey's Valuation calls the numerator NOPLAT (net operating profit less adjusted taxes), and some texts say EBIAT. Damodaran says after-tax operating income. NOPAT, NOPLAT and EBIAT are the same idea, with minor definitional differences flagged where they matter. Indian practice speaks of ROCE, defined in ROIC vs ROCE and used alongside ROIC throughout.