To make sure that business growth is sustainable, companies need to invest in working capital and fixed assets – new facilities and technology. These investments can be financed through Equity and/or Debt.
One of the owner’s key tasks is to find the optimal balance between funding sources that maximizes the shareholder value while maintaining adequate level of risk.
Invested capital is comprised of two components:
Both shareholders and lenders expect a return on the capital they provide. Lenders earn from interest payments, and what they expect to earn given certain risk profile is cost of debt for the company. Shareholders receive dividends and benefit from the appreciation of their shares, and what they expect to earn also given risk profile of the company is called cost of equity.
From the company’s perspective, the overall cost of capital is calculated based on the share of debt and equity in its financing structure – this is the Weighted Average Cost of Capital or WACC. It represents the average cost of each source of capital, weighted by its proportion in the company’s total financing structure.
When a company invests its own and borrowed funds, it is crucial to ensure these funds are utilized efficiently – generating returns exceeding their cost.
This is where a key metric comes in – Return on Invested Capital or ROIC. It measures how much operating profit the company generates for every unit of invested capital.
Many companies associate growth with higher sales, expansion, new branches and investments. But growth of business by itself is not necessarily positive for shareholders – it can either create or destroy value. The key question any business owner must ask is:
To assess how efficiently a business uses capital, ROIC is compared to WACC.
Only when ROIC exceeds WACC, the company is creating shareholder value. If ROIC is lower, then even if the business is growing, it is earning less than what the capital used to finance that growth cost – which means shareholder value is being destroyed.
where
D – Financial Debt;
E – Equity
Rd – Cost of Debt;
Re – Cost of Equity;
T – Corporate Income Tax Rate.
where
EBIT – Earnings before interest and tax;
Average IC – Average invested capital.
| If... | … it means | Consequences |
|---|---|---|
| Capital is generating returns higher than its cost | Business |
|
| Capital returns are lower than the cost of capital | Business | |
| No losses, but no added value |
Consider three hypothetical companies with the same amount of invested capital but different capital structures and profitability levels:
This example illustrates how differences in capital structure and business efficiency influence each company’s ability to increase shareholder wealth.
Company A: Equity-dominated capital structure and high investment efficiency
Company A achieves the highest economic profit (₽ 33,6 M) due to:
Company B: Equity-dominated capital structure but lower investment efficiency
Company B destroys shareholder value because its WACC exceeds its ROIC:
Company C: Debt-dominated capital structure and high investment efficiency
Company C generates low economic profit despite a high ROIC:
| Indicator | Company A | Company B | Company C | |||
|---|---|---|---|---|---|---|
| ₽ M | Cost, % | ₽ M | Cost, % | ₽ M | Cost, % | |
| Average invested capital | 1 000 | 21,6% | 1 000 | 21,6% | 1 000 | 24,5% |
| Equity | 700 | 24,4% | 700 | 24,4% | 300 | 35,1% |
| Debt | 300 | 19,0% | 300 | 19,0% | 700 | 25,0% |
| NOPAT1 | 250 | 150 | 250 | |||
| WACC2 | 21,6% | 21,6% | 24,5% | |||
| ROIC3 | 25,0% | 15,0% | 25,0% | |||
| EP Spread4 | 3,36% | -6,64% | 0,48% | |||
| Economic profit (EP5) | 33,6 | (66,4) | 4,8 | |||
MDMG (the “Mother and Child” Group) is a leading player in the Russian private healthcare market, consistently ranking among the Top 3 in revenues and market coverage. Since 2018, MDMG has only delivered positive economic profit to its shareholders – a direct indication of the company’s effective use of invested capital. MDMG’s business generates returns (NOPAT) that exceed the cost of both equity and debt capital (IC). This means the company’s shareholder value has been steadily increasing.
In 2024, MDMG’s Economic profit (EP) reached a record ₽ 1,6 B. A key driver of this success is the consistently high and growing ROIC – rising from 14,7% in 2018 to 26,9% in 2024. At the same time, MDMG’s Weighted Average Cost of Capital (WACC) has remained below 23%, resulting in a substantial positive spread.
This gap between returns and the cost of capital means that each ruble invested generates increasing additional value.
The growth in NOPAT margin (from ~20% to 27%) also reflects improved operational efficiency and better cost management.
It is worth noting that MDMG maintains a balanced capital structure: the share of debt financing has been gradually decreasing, while equity has been growing, providing a stable financial platform.
This approach allows the company not only to generate profits but also to minimize risks associated with leverage. Taken together, these trends highlight the maturity of MDMG’s business model and its strong ability to create long-term shareholder value.
| Reporting period | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 |
|---|---|---|---|---|---|---|---|
| Revenues | 14,9 | 16,2 | 19,1 | 25,2 | 25,2 | 27,6 | 33,1 |
| NOPAT | 3,0 | 3,0 | 4,3 | 6,5 | 4,8 | 7,3 | 8,8 |
| NOPAT margin | 20,1% | 18,4% | 22,7% | 25,7% | 19,1% | 26,6% | 26,5% |
| Average invested Capital1 | 20,4 | 23,0 | 25,3 | 27,1 | 27,4 | 30,8 | 32,7 |
| Equity | 15,3 | 16,9 | 18,9 | 21,5 | 25,0 | 30,8 | 32,7 |
| Debt | 5,1 | 6,1 | 6,4 | 5,6 | 2,4 | 0,0 | 0,0 |
| ROIC | 14,7% | 12,9% | 17,2% | 23,9% | 17,6% | 23,9% | 26,9% |
| WACC2 | 14,4% | 12,1% | 11,9% | 15,9% | 16,3% | 20,0% | 23,4% |
| EP Spread | 0,3% | 0,8% | 5,3% | 7,9% | 1,2% | 3,8% | 3,5% |
| Economic Profit (EP) | 0,1 | 0,2 | 1,3 | 2,1 | 0,3 | 1,2 | 1,1 |
This case clearly demonstrates how significantly capital efficiency impacts creation of shareholder value. Despite having similar revenue levels in 2020, the two companies show fundamentally different dynamics in ROIC, WACC and Economic Profit (EP).
Company Х is an example of efficient growth. Its NOPAT margin has been steadily increasing (1,5% to 6,5%) and by 2022 its ROIC exceeded 40%. At the same time, the cost of capital (WACC) has been gradually declining and since 2021 EP has remained consistently positive. This indicates that the business is scaling without losing efficiency and is creating additional value for its owners.
Company Y, on the other hand, is unable to deliver returns above its cost of capital even as revenues grow. In 2021, ROIC temporarily exceeded WACC, but by 2022 operating profitability deteriorated (NOPAT margin fell into negative territory), while WACC consistently remained above ROIC. This resulted in negative EP and destruction of shareholder value.
A sustained excess of ROIC over WACC is the key hallmark of an efficient, resilient business that creates shareholder value. Even moderate growth with high profitability is better than expansion accompanied by negative economic profit.
| Indicator | Company Х | Company Y | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2020 | 2021 | 2022 | 2023 | 2024 | 2020 | 2021 | 2022 | 2023 | 2024 | |
| Revenues | 6,9 | 7,1 | 9,6 | 10,5 | 13,7 | 6,2 | 6,5 | 7,6 | 6,5 | 8,1 |
| NOPAT | 0,1 | 0,3 | 0,8 | 0,7 | 0,9 | 0,4 | 0,3 | 0,4 | (0,1) | 0,3 |
| NOPAT margin, % | 1,5% | 4,0% | 8,3% | 6,4% | 6,5% | 7,0% | 3,9% | 4,9% | -0,9% | 4,2% |
| Invested Capital1 | 1,6 | 1,4 | 2,3 | 3,5 | 6,0 | 2,4 | 2,4 | 2,7 | 2,7 | 2,8 |
| Equity | 0,4 | 0,5 | 1,1 | 1,7 | 2,6 | 0,9 | 1,0 | 1,1 | 1,0 | 1,0 |
| Debt | 1,1 | 0,9 | 1,2 | 1,8 | 3,5 | 1,5 | 1,4 | 1,6 | 1,7 | 1,7 |
| ROIC | 6,8% | 19,0% | 43,1% | 23,4% | 18,8% | 19,6% | 10,6% | 14,7% | -2,3% | 12,4% |
| WACC2 | 8,5% | 9,5% | 19,1% | 15,2% | 17,3% | 8,7% | 9,6% | 18,0% | 14,8% | 17,0% |
| EP Spread | -1,7% | 9,5% | 24,0% | 8,2% | 1,5% | 10,9% | 1,1% | -3,4% | -17,0% | -4,7% |
| Economic Profit (EP) | 0,0 | 0,1 | 0,4 | 0,2 | 0,1 | 0,2 | 0,0 | (0,1) | (0,5) | (0,1) |
When comparing ROIC and WACC, it is important to keep in mind several nuances to avoid “comparing apples to oranges”.
When calculating ROIC, balance sheet (or historical) values of equity and debt are used. For WACC, however, market values should be applied for public companies or levels of leverage from comparable companies for private firms.
ROIC is calculated based on operating profit (NOPAT) – a metric from the Profit & Loss statement (P&L) that reflects a company’s operational efficiency. WACC usually incorporates current market cost of capital, which reflects market expectations. This means that past performance (ROIC) is being compared to future expectations (WACC), creating a timing mismatch that should be taken into account.
Capitalizing costs directly affects invested capital and, therefore, ROIC.
ROIC should only account for operating assets. Excess cash, surplus real estate or other non-operating assets should be excluded. Including them inflates invested capital and reduces ROIC.
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