Q.From the illustrative data in Section 1 (Net Profit after Tax ₹2,70,000; Shareholders' Funds ₹8,00,000; Net Profit before Interest and Tax ₹4,00,000; Long-term Debt ₹4,00,000), calculate the Return on Investment (Return on Shareholders' Funds) and the Return on Capital Employed.

Return on Investment measures the return to the owners on their own funds, while Return on Capital Employed measures the return on all long-term funds put into the business.

Step 1 - Return on Investment (Return on Shareholders' Funds).

Return on Investment = (Net Profit after Tax / Shareholders' Funds) x 100 = (2,70,000 / 8,00,000) x 100 = 33.75%.

This is the return earned for the owners on the funds they have invested, measured after interest and tax (since interest belongs to the lenders and tax to the government, what remains is the owners' return).

Step 2 - Capital Employed.

Capital Employed = Shareholders' Funds + Long-term Debt = 8,00,000 + 4,00,000 = ₹12,00,000.

Step 3 - Return on Capital Employed (ROCE).

Return on Capital Employed = (Net Profit before Interest and Tax / Capital Employed) x 100 = (4,00,000 / 12,00,000) x 100 = about 33.33%.

ROCE uses profit before interest and tax because that profit is the total return available to reward both providers of long-term capital (owners and lenders), so it must be measured before interest (the lenders' share) is deducted. …

Consistency of numerator and denominator is the key: ROI pairs after-tax profit with owners' funds only; ROCE pairs pre-interest, pre-tax profit with total capital employed. Mixing them (e.g. after-ta …

A common mistake is using Net Profit AFTER interest and tax in the ROCE numerator - ROCE deliberately uses profit BEFORE interest and tax, because Capital Employed includes long-term debt, so the return measured …