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    Alizah
    ROIC affects a company's cash flow by determining the returns generated and costs of capital, with higher ROIC and lower costs leading to higher cash flow. Growth and cash flow are also related, as higher proportions of cash flow allow for greater growth and value. While growth is important, it can destroy value if ROIC is lower than the cost of capital. In this case, companies should focus on improving returns before growing. An electric utility would benefit more from improving ROIC than increasing growth, as utilities have regulated markups and monopolies discourage high ROIC, so they should eliminate unprofitable assets to improve returns rather than focus on growth.

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    Module 1 - Post Task

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    ROIC affects a company's cash flow by determining the returns generated and costs of capital, with higher ROIC and lower costs leading to higher cash flow. Growth and cash flow are also related, as higher proportions of cash flow allow for greater growth and value. While growth is important, it can destroy value if ROIC is lower than the cost of capital. In this case, companies should focus on improving returns before growing. An electric utility would benefit more from improving ROIC than increasing growth, as utilities have regulated markups and monopolies discourage high ROIC, so they should eliminate unprofitable assets to improve returns rather than focus on growth.

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    ROIC affects a company's cash flow by determining the returns generated and costs of capital, with higher ROIC and lower costs leading to higher cash flow. Growth and cash flow are also related, as higher proportions of cash flow allow for greater growth and value. While growth is important, it can destroy value if ROIC is lower than the cost of capital. In this case, companies should focus on improving returns before growing. An electric utility would benefit more from improving ROIC than increasing growth, as utilities have regulated markups and monopolies discourage high ROIC, so they should eliminate unprofitable assets to improve returns rather than focus on growth.

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    Download as docx, pdf, or txt
    541 views2 pages

    Module 1 - Post Task

    Uploaded by

    Alizah
    ROIC affects a company's cash flow by determining the returns generated and costs of capital, with higher ROIC and lower costs leading to higher cash flow. Growth and cash flow are also related, as higher proportions of cash flow allow for greater growth and value. While growth is important, it can destroy value if ROIC is lower than the cost of capital. In this case, companies should focus on improving returns before growing. An electric utility would benefit more from improving ROIC than increasing growth, as utilities have regulated markups and monopolies discourage high ROIC, so they should eliminate unprofitable assets to improve returns rather than focus on growth.

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    1. How does return on invested capital (ROIC) affect a company’s cash flow?

    Explain the
    relationship between ROIC, growth, and cash flow.

    Return on invested capital (ROIC) is one of the key variables when it comes to the valuation of a
    certain company. And this value created by the company is also predetermined by the cash flows
    generated and by the growth of the company itself. Hence, we can say that, for a company to create
    value it must not only focus on one factor of its value-creating aspects, instead, it must correlate them
    accordingly to be able to increase rather than destroy the company's value. ROIC is the return that is
    generated by the company on the invested capital. High ROIC is always better for the company and vice
    versa. Growth on the other hand is the increase in revenues over a certain period of time. Investors and
    shareholders aspire for higher growth of return and value. Cash flow for the company is the difference
    between the cash inflows and outflows and companies are able to determine it through preparation of
    cash flow statement. This helps them understand the changes in cash position over a period of time. So
    how does ROIC affect a company’s cash flows? It was said that cash flow is the difference between the
    inflows and outflows, therefore it is actually the difference between the returns generated minus the
    cost of capital. This leads to the conclusion that higher ROIC and lower cost of capital leads to higher
    cash flow for the company. Then, higher the proportion of cash flow, greater is the growth and greater
    is value generated by the company and vice versa. Thus, greater value was created for the shareholders
    that would surely attract more investors. With this, we can conclude that ROIC and cash flow are related
    to each other.

    2. Under what circumstances does growth destroy value?

    There are times when companies focus too much on increasing their growth rather than focusing on
    aiming a higher ROIC. However, having high percentage of growth does not always guarantee an
    increase of value for the company. For instance, there are these two companies which both have the
    same value but one of them has a slow growth compared to the faster-growing company. The reason is
    that the slower-growing company focused on maintaining its high ROIC which indicated the increase of
    their value. Earnings and cash flow are often correlated, but earnings don’t tell the whole story of value
    creation, and focusing too much on earnings or earnings growth often leads companies to stray from a
    value-creating path. Hence, when ROIC is high, faster growth increases value. But when ROIC is lower
    than company’s cost of capital, faster growth destroys value. With this, we can conclude that high-ROIC
    companies should focus on growth, while low-ROIC companies should focus on improving returns
    before growing.

    3. Which type of business, a pharmaceutical firm or an electric utility, would benefit more from
    improving ROIC than from increasing growth? Why?

    The electric utility would likely benefit more from improving ROIC than from increasing growth.
    Pharmaceutical firms have a long process in order to develop and manufacture its products which
    entails a much larger general cost for them to be able to operate well in the industry. Also,
    pharmaceutical firms fall under pure competition. It means that they belong in a market structure in
    which large number of sellers offer homogeneous products in the market. With that, these kinds of
    companies who belong to such market structure and have such complex process to operate, like
    pharmaceutical firms, would most probably impose a higher mark-up than electric utilities in order to
    assure earnings. This indicates that pharmaceutical companies tend to have high ROIC which implcitly
    advises them to focus on their growth. Thus, focusing on improvement of ROIC is more beneficial in
    electric utilities. Electric utilities belong to monopolistic market structure which means that one
    company is already enough to control the entire industry, hence a result of continuous growth due to a
    less tensed competition and a less saturated market. Also, electric utilities have to be carefully regulated
    by higher authorities in order to protect the interests of their captive customers. Apparently, most of
    the terms and conditions stated in such agreement with the said regulators are somehow unfavorable to
    the concept of high ROIC. Their mark-ups cannot be as high as other types of companies. Although they
    have continuous growth because of the fact that electricity is already considered as an essential or basic
    need of the people, they must still focus on improving their ROIC in order for them to increase their
    company’s value. They could actually circumvent this dilemma without imposing the high-mark-up
    strategy, instead, they could eliminate non-earning assets or noncontributing areas of the company for
    them to be able to improve ROIC.

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