Cash-flow return on investment (CFROI) is a valuation model that assumes the

stock market A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include ''securities'' listed on a public stock exchange, as ...

sets prices based on

cash flow A cash flow is a real or virtual movement of money: *a cash flow in its narrow sense is a payment (in a currency), especially from one central bank account to another; the term 'cash flow' is mostly used to describe payments that are expected ...

, not on corporate performance and earnings. :

\text = \frac

For the corporation, it is essentially

internal rate of return Internal rate of return (IRR) is a method of calculating an investment’s rate of return. The term ''internal'' refers to the fact that the calculation excludes external factors, such as the risk-free rate, inflation, the cost of capital, or fin ...

(IRR). CFROI is compared to a hurdle rate to determine if investment/product is performing adequately. The hurdle rate is the total cost of capital for the corporation calculated by a mix of

cost of debt In economics and accounting, the cost of capital is the cost of a company's funds (both debt and equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is used to evaluate new ...

financing plus investors' expected

return on equity The return on equity (ROE) is a measure of the profitability of a business in relation to the equity. Because shareholder's equity can be calculated by taking all assets and subtracting all liabilities, ROE can also be thought of as a return on '' ...

investments. The CFROI must exceed the hurdle rate to satisfy both the debt financing and the investors

expected return The expected return (or expected gain) on a financial investment is the expected value of its return (of the profit on the investment). It is a measure of the center of the distribution of the random variable that is the return. It is calculated ...

. :

\text = \frac

Michael J. Mauboussin Michael J. Mauboussin (born February 1964) heads consilient research at Morgan Stanley division Morgan Stanley Investment Management's Counterpoint Global, an open-end mutual fund. Previously, he was director of research at BlueMountain Capital and ...

in his 2006 book ''More Than You Know: Finding Financial Wisdom in Unconventional Places'', quoted an analysis by

Credit Suisse First Boston Credit Suisse First Boston (also known as CSFB and CS First Boston) is the investment banking affiliate of Credit Suisse headquartered in New York. The company was created by the merger of First Boston, First Boston Corporation and Credit Suisse, ...

, that, measured by CFROI, performance of companies tend to converge after five years in terms of their survival rates. The CFROI for a firm or a division can then be written as follows: :

\text = \frac

This annuity is called the economic depreciation: :

\text = \frac

where ''n'' is the expected life of the asset and ''K''_''c'' is the

replacement cost The term replacement cost or replacement value refers to the amount that an entity would have to pay to replace an asset at the present time, according to its current worth. In the insurance industry, "replacement cost" or "replacement cost valu ...

in current dollars.

See also

References

Further reading