Aswithprice-to-bookratios,therelationshipisclear.When
excessreturnsarepositive(i.e.,thereturnoncapitalexceeds
thecost of capital),the enterprise value-to-invested capital
ratioisgreaterthan1.Whenthereturnoncapitalislessthan
the cost of capital, firms will trade below book capital.
FIGURE9.4EnterpriseValue/CapitalInvestedversusExcess
Returns
The discussion can also be reframed around the after-tax
operating margin,sincechangingthemarginwhileholding
the sales-to-capital ratio fixed will change the return on
capital:
Ifwechangetheafter-taxoperatingmargininIllustration9.2
whileholdingthesalestocapitalratioandexpectedgrowth