In this example, a company division has the following figures. It has profit of 1,350 and invested capital of 7,500.

It is considering investing in cost saving equipment. The extra savings per annum will be 60, the extra depreciation cost per annum will be 15 and the cost of the equipment at the start of the project will be 75. We're told the company has a threshold return of 12%. i.e., any returns less than 12% will definitely not be invested in. Our question is will it invest in the cost saving equipment? Well, if we look at the return on capital currently being seen, they own a profit of 1,350 divided by 7,500, gives them a current return of 18%. So far in excess of their threshold return of 12%, this division seems to be doing well. But now let's look at the cost saving equipment. Well, the return earned is going to be 60 minus the 15. So each year they're gonna be earning an extra 60 from the cost savings, but less the 15 for the extra cost. So they've got return of 45 per year. We divide that through by the cost of the equipment 75. This means they're getting a return of 60% per year. This is far in excess of the threshold return of 12% and it's actually much higher than the division's current return on capital of 18%. However, if the return on the new project was 17%, would we see the investment happening? Well, because it's still higher than the threshold return of 12%, we should say yes, absolutely, it should be invested in. But we sometimes find that divisional managers, if they have a current return of 18% and they're now looking at a new project of 17%, they may be unwilling to invest in that project of 17% because it would bring the division's current return of 18% down. So return on capital is fantastic for comparing projects and helping us make decisions, but it can sometimes lead to dysfunctional behavior.