Stable Return on Capital Scenario
When a firm has a stable return on capital, its expected
growthinoperatingincomeisaproductofthereinvestment
rate—thatis,theproportionoftheafter-taxoperatingincome
that is invested in net capital expenditures and noncash
working capital, and the quality of these reinvestments,
measured as the return on the capital invested.
In making these estimates, we use the adjusted operating
incomeandreinvestmentvaluesthatwecomputedinChapter
4.Bothmeasuresshouldbeforwardlooking,andthereturn
oncapitalshouldrepresenttheexpectedreturnoncapitalon
futureinvestments.Intherestofthissubsection,weconsider
howbesttoestimatethereinvestmentrateandthereturnon
capital.
Reinvestment Rate
Thereinvestmentratemeasureshowmuchafirmisplowing
backtogeneratefuturegrowth.Thereinvestmentrateisoften
measuredusingthemostrecent financialstatementsforthe
firm. Although this is a good place to start, it is not
necessarilythebestestimateofthefuturereinvestmentrate.A
firm’sreinvestmentratecanebbandflow,especiallyinfirms
thatinvestinrelativelyfewlargeprojectsoracquisitions.For
thesefirms,lookingatanaveragereinvestmentrateovertime