CFROI serves as a central yardstick in evaluating individual strategies and business areas. Along the lines of a key figure for yield, the CFROI calculates the average interest earned on the entire invested capital at a given point in time. Unlike the other methods, which are oriented toward the capital value method, CFROI is calculated using the internal rate of return method.
The following elements form the basis of Lewis’ approach: gross cash flow as a periodic profit figure, the gross investment basis (acquisition costs of assets) for the amount of capital, the useful life of fixed assets, and the net book value of nondepreciable assets at the end of their useful life. The CFROI is compared with the average overall capital costs of the firm with the effects of taxes and inflation removed. Lewis rejects the idea of calculating capital costs using CAPM. Instead, he derives the equity costs adjusted to risk empirically by using a stock portfolio.
Cash value added (CVA), as an absolute periodic profit figure, is used for Performance Measurement. It is the result of multiplying the difference between CFROI and the average capital costs of the period by the gross investment basis. A positive CVA points to an increase in value, while a negative CVA indicates a reduction.
CVA = (CFROI – WACC) * Gross Investment Basis
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