Forexample,afirmthatseesitsreturnoncapitalimproves
from 10 percent to 11 percent while maintaining a
reinvestmentrateof 40 percentwillhaveanexpectedgrowth
rate of:
Ineffect,theimprovementinthereturnoncapitalincreases
the earnings on existing assets and this improvement
translates into an additional growth of 10 percent for the firm.
Candidates for Changing Average Return on Capital
Whattypesoffirmsarelikelytoseetheirreturnoncapital
change overtime? Onecategory wouldinclude firms with
poorreturnsoncapitalthatimprovetheiroperatingefficiency
andmargins,andconsequentlytheirreturnoncapital.Inthese
firms,theexpectedgrowthratewillbemuchhigherthanthe
productofthereinvestmentrateandthereturnoncapital.In
fact,sincethereturnoncapitalonthesefirmsisusuallylow
beforetheturnaround,smallchangesinthereturnoncapital
translate into big changes in the growth rate. Thus, an
increase in thereturnon capital onexisting assets from 1
percent to 2 percent doubles the earnings (resulting in a
growth rate of 100 percent).
Theothercategorywouldincludefirmsthathaveveryhigh
returnsoncapitalontheirexistinginvestmentsbutarelikely
tosee thesereturns slipascompetitionentersthebusiness,
not only on new investments but also on existing investments.
ILLUSTRATION 4.9: Estimating Expected Growth with
Changing Return on Capital: Blockbuster