What is Reinvestment Rate?
The Reinvestment Rate measures the percentage of a company’s after-tax operating income (i.e. NOPAT) that is allocated to capital expenditures (Capex) and net working capital (NWC).
How to Calculate Reinvestment Rate (Step-by-Step)
The expected growth rate in operating income is a byproduct of the reinvestment rate and the return on invested capital (ROIC).
- Reinvestment Rate: The proportion of NOPAT re-invested into capital expenditures (CapEx) and net working capital (NWC).
- Return on Invested Capital (ROIC): The profitability (%) earned by a company using its equity and debt capital.
The calculation of the rate of a company’s reinvestment is a three-step process:
- Step 1: First, we calculate net CapEx, which is equal to capital expenditures minus depreciation.
- Step 2: Next, the change in net working capital (NWC) is added to the result from the prior step, representing the dollar amount of reinvestment.
- Step 3: Lastly, the value of the reinvestment is divided by the tax-affected EBIT, i.e. net operating profit after taxes (NOPAT).
Reinvestment Rate Formula
The formula for calculating the reinvestment rate is as follows.
Where:
- Net Capital Expenditure (Capex) = Capex – Depreciation
- NOPAT = EBIT × (1 – Tax Rate %)
The change in NWC is considered a reinvestment because the metric captures the minimum amount of cash necessary to sustain operations.
- Increase in NWC ➝ Less Free Cash Flow (FCF)
- Decrease in NWC ➝ More Free Cash Flow (FCF)
Note that the net working capital (NWC) calculation includes only operating items, and thereby excludes cash and cash equivalents, as well as debt and any related interest-bearing liabilities.
Hi, very detailed explanation!
Btw, can I check the reason for minus the depreciation from CAPEX?
Thanks!
Hi, thank you fir the post!
How do you arrive at the expected growth rate equaling the product of ROIC and reinvestment rate? Thanks!
Hello, nice work!!
I would like to ask; If the Change in WC were +40 instead of -40, would you add it to Net CAPEX or would you subtract it from the Net CAPEx?
Thanks