In this workout, we are going to calculate return on invested capital for Air France, KLM in 2018. Now, Air France, KLM, is a European airline and the question asks us to assume that the return obligation liability and other provisions are interest bearing, which means they are part of the financial liabilities of the business and therefore included within invested capital. We're also asked to assume that sales of aircraft, equipment and other non-current income and expenses are non-recurring, which means they should be excluded from EBIT and therefore also NOPAT. Now looking at the face of the income statement, we can see that income from current operations is 1.3 billion Euros, and that already excludes those non-recurring items. So this gives us the EBIT that we are going to use in our notepad calculation.

We can also see that we've been given the effective tax rate of 36.4%. So calculating NOPAT is very straightforward. We're just going to take the EBIT and multiply it by one minus the effective tax rate, and that gives us NOPAT of 846.7.

The next step is to identify invested capital, and that's based on the values provided in the balance sheet. Now let's have a look at what we've got in the balance sheet.

Well, as you'd expect, we're going to have shareholders, equity included, invested capital, but the balance sheet also shows a number of other items that we need to include that make up the financing of the business. For example, we have non-controlling interests. There are also pension provisions and a return obligation liability and financial debt, which includes bank borrowings and possibly issued bonds. We also have lease liabilities and bank overdrafts. So those are all the financial liabilities and equity. What about on the other side of the balance sheet? Well, within assets, we also have some items that we need to include in our invested capital. These items are not part of the operations of the business, and that includes equity associates, which are sometimes referred to as equity method investments. There are also pension assets and other financial assets as well as cash and cash equivalents. One way to look at this is to assume that any item which is generating interest income or incurring interest expense would likely be included in our invested capital calculation. Since it's not directly involved in generating operating profits of the business, we also need to remember that assets items need to be deducted from liabilities and equity.

Now, luckily for us, all of the numbers have been extracted from the balance sheet and placed here, and these are prior year figures because we're going to calculate return on opening invested capital. Also note that the asset items are shown as a negative because those are going to be deducted from our invested capital calculation, so we can simply sum together all of these items to give total invested capital of 12,916. Return on invested capital calculation is then very straightforward. We just need to take our NOPAT and divide that by total invested capital and that gives us a return on invested capital of 6.6%.

Now looking at the return on invested capital, is this high or low? Well, the airline industry is very capital intensive. They have a particularly large asset base reflecting the owned and leased aircraft, and this results in a very high level of capital employed or invested capital, but it's also a very competitive industry. Profit margins have been eroded over recent years, and margins are very low compared to other sectors. So combining high levels of invested capital and low profit margins results in very low return on invested capital. In fact, the airline industry has some of the lowest returns across the whole market.