Suppose a company’s return on invested capital is less than its WACC. What happens to the value of operations if the sales growth rate increases? Explain your answer.
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Suppose a company’s return on invested capital is less than its WACC. What happens to the value of operations if the sales growth rate increases? Explain your answer. |
Explanation
When return on capital invested (ROIC) is less than the weighted average cost of capital (WACC), an increase in the sales growth rate will not increase the value of operations. This is because no profit is generated as returns from a project are not even sufficient to cover the cost. So, the value of operations will remain negative.
Verified Answer
When return on invested capital (ROIC) is less than weighted average cost of capital (WACC), then the value of operations will be less than the value of operating capital even if sales growth increases.
This is so because the company is not able to generate profits out of its capital invested.
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