Cash flow return on investment is a valuation

Valuation (finance)

In finance, valuation is the process of estimating what something is worth. Items that are usually valued are a financial asset or liability. Valuations can be done on assets or on liabilities...

 model that assumes the stock market

Stock market

A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...

 sets prices based on cash flow

Cash flow

Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...

, not on corporate performance and earnings.

CFROI = Cash Flow / Market Recapitalization

For the corporation, it is essentially internal rate of return

Internal rate of return

The internal rate of return is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return or the rate of return . In the context of savings and loans the IRR is also called the effective interest rate...

 (IRR). CFROI is compared to a hurdle rate

Corporate finance

Corporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize shareholder value while managing the firm's financial risks...

 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 financing plus investors `expected return on equity

Return on equity

Return on equity measures the rate of return on the ownership interest of the common stock owners. It measures a firm's efficiency at generating profits from every unit of shareholders' equity . ROE shows how well a company uses investment funds to generate earnings growth...

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

Expected gain

The expected gain is the weighted-average most likely outcome in gambling, probability theory, economics or finance.-Discrete scenarios:In gambling and probability theory, there is usually a discrete set of possible outcomes...

.

CFROI = Gross Cash Flow / Gross Investment

Michael J. Maubossin, in his 2006 book 'MORE THAN YOU KNOW', quoted an analysis by CSFB, 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:

CFROI = (Gross Cash Flow - Economic Depreciation) / Gross Investment

This
annuity is called the economic depreciation.

Economic Depreciation = (Replacement Cost

Replacement value

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 Current dollars (Kc)) / ((1+ Kc )^n - 1)

where n is the expected life of the asset.

See also

• Return of capital
  Return of capital
  Return of capital refers to payments back to "capital owners" that exceed the growth of a business. It should not be confused with return on capital which measures a 'rate of return'....
  
  
• External discussion of Flow Return on Investment at the Business KPI Wiki