What's more important when evaluating an investment financially, NPV or ROIC?

Hi there,

Q: Which would be the most financially attractive investment and why?

To answer the question, I would consider the following:

1. What is the goal of the client. Different clients might have different goals, making the ideal scenario not always the same.
2. Do we have the capabilities to implement the best option. From what you shared it seems that the invested capital is different in the two scenarios. We might have the invested capital for one of the options but not for the other.

Bonus: you could consider if there is any synergy or cannibalization related to the investment with the rest of the business of the client.

Best,

Francesco

Hi there,

I would be happy to share my thoughts on it:

• First of all, in industries where evaluating investments is part of daily business, such as private equity, those investments are evaluated from various angles, including NPV and different types of transactional and/or trading multiples. As such, without more context about the background of this specific investment, it is very hard to provide a meaningful answer.
• Nevertheless, generally speaking, since NPV accounts for the risk associated with the investment while ROIC does not, I would advise you to focus more on NPV.
• Lastly, please keep in mind that mathematically complex valuation methods like NPV are usually not used in case studies.

If you would like a more detailed discussion on how to address your specific situation, please don't hesitate to contact me directly.

Best,

Hagen

Hi there,

while NPV is an absolute number, while ROIC is a relative number. The benefit of NPV is that it accounts for scale. The ROIC of a niche business could be high but not scalable. NPV accounts for that. 

Hope this helps.

Andreas

Hi there,

NPV = Absolute gain

ROIC = Relative gain

So, would you rather have $100 after working 10 hours or $50 after working 2 hours?

The 1st option has a higher absolute value (NPV) but the 2nd option gives you more money for your effort (ROIC).

Make sense?

Companies tend to use ROIC, but the true answer is: it depends. And, in a case, do what the interviewer (i.e. the client) says :)

Hi there, 

Wanted to note here for you and for other candidates that NPV rarely comes up in interviews. It's one of these terms that everybody is concerned about but really they almost never show up. And if they do, you can always ask the interviwer for the formula. 

Best,
Cristian

NPV measures the efficiency of the investment, and to be honest is rarely used in real life. If you want to measure the efficiency though, people tend to use the internal rate of return, or IRR, which is a better measure of profitability. ROIC measures the capital which you gain and is what is used on all investments. 

Investment is usually about allocating resources, so ROIC is usually better, because it means more profitability for the same ammount of investment.

Now this assumes that risk profiles are similar. NPV takes risk into consideration, but ROIC does not. So, if risk profiles are significantly different, then NPV is critical.

To be honest, the dichotomy is a bit artificial. Nothing prevents an investor from using both. In reality, they always do.