In this workout, we are asked to calculate the first forecast year's return on invested capital and then we're asked to calculate the second forecast year's EBIT, assuming the company reinvests three during the first forecast year and continues to generate the same return on invested capital. Let's start off with calculating the first forecast year's return on invested capital. Now, we are told that the company's current invested capital is 100 and the EBIT for the first forecast year is 10. We're also told that the company's effective tax rate is 20%. So the taxed EBIT or NOPAT is EBIT multiplied by one minus the effective tax rate, which gives NOPAT of eight. Given that we only have the opening invested capital for this company, we will use that to calculate return on opening invested capital. And for that, we simply need to divide NOPAT of eight by the invested capital of 100 and that gives return on invested capital of 8%.

The question then tells us that the company reinvests three of this profit during the first forecast year. This must mean that the operating assets, that's the capital employed in the business, increases by three. Since we know that capital employed and invested capital are equal, this means that invested capital must increase by three as well. So if we scroll down, we can use this to calculate the invested capital at the end of the first forecast year. That's gonna be the invested capital at the start of the year of 100 plus the profits which are reinvested of three. So the invested capital at the end of that year is 103. Now, if the company is still generating an 8% return on its invested capital in the second forecast year then the NOPAT which it generates in the second forecast year is going to be 8% of 103.

And that gives us NOPAT of 8.2 in the second forecast year. We can then back out the tax effect by dividing the NOPAT by one minus the effective tax rate 20% and that gives EBIT in the second forecast year of 10.3. Now look what happens if I calculate the growth in invested capital and the growth in profits. So, the growth in invested capital is the invested capital at the start of the second forecast year and the invested capital at the start of the first forecast year and that gives a growth rate of 3%. Right now, calculate the growth in EBIT that's the EBIT for the second forecast year compared with the EBIT for the first forecast year. That gives a growth rate also of 3%. Now, when we talk about growth rates for a company people often ask, should we focus on capital growth or earnings growth? Well, as you can see here, if we're talking about a company which is generating stable returns, for example a company that's in its terminal phase, then the two should be exactly the same. Also, we can see here that there's an explicit link between earnings growth and reinvestment in the business. If a company is generating stable returns then the invested capital has to grow at the same rate as earnings. And as you can see, the growth in invested capital comes from reinvestment.