Capitalizing Expensed Investments  473
assets) does not materially affect perceptions of performance: for PharmaCo, ROIC 
would be 8.9 percent for a 12-year life, versus 9.4 percent for an eight-year life. 
This pattern remains unchanged when R&D spending is much lower—for ex-
ample, at only 10 percent of revenues. Furthermore, when using ROIC to compare 
the performance of competing companies, what matters most is that asset lifetime 
estimates are consistent across all companies. Keep in mind that the lifetimes for 
tangible assets are also based on rough estimates and accounting conventions. 
Yet most managers and analysts are quite comfortable using tangible-asset book 
values and depreciation charges as the basis for return on capital and earnings.7
Interpreting Return on Capital, Including Capitalized Expenses
In general, capitalizing intangible investments will lead to lower ROIC. For 
mature companies with stable revenues and investment spending, the amor-
tization charges for intangible assets are likely to be close to the amounts 
expensed. As a result, capitalizing the expenses may have little impact on 
NOPAT. But the capital base will always increase when the expenses are capi-
talized, leading to lower ROIC.
Although the capitalization can never change historical free cash flows, as 
discussed in the PharmaCo example, the resulting adjustments to capital turn-
over and ROIC can affect projections of future free cash flows. For PharmaCo, 
required investments in R&D to achieve growth of 10 percent per year would 
be estimated at $375 million in 2021, which is $113 million more than the $262 
million spent in 2020. This follows from required growth of the net R&D asset 
base (10 percent, or $167 million) plus an annual amortization charge of $208 
million (one-eighth of the 2020 ending balance). When R&D investments going 
forward would be modeled as expenses, the required additional R&D outlay 
in 2021 would be only 10 percent of the additional 2021 revenues, or $26 mil-
lion. This is comparable to what happens to investment projections if capital 
expenditures for tangible assets are derived from a constant ratio to revenues 
or instead implied from a constant capital turnover (see Chapter 13).
If PharmaCo can increase its revenues by 10 percent as a result of increas-
ing its R&D expenses by 10 percent, the unadjusted ROIC provides the best es-
timate of the IRR of future investments in its business. In contrast, if achieving 
that same revenue growth would require PharmaCo to increase its net R&D 
asset base, rather than its R&D expenses, by 10 percent, the adjusted ROIC is 
the better estimate. Of course, these R&D investment estimates for PharmaCo 
are not likely to apply from year to year. What matters is which R&D invest-
ments are required for growth over the long term.
More accurately reflecting the economics of intangible investments on 
ROIC can have major implications for investment decisions, performance 
7 Note also that for an alternative measure of ROIC, such as cash flow return on investment (CFROI) 
with or without resource capitalization, estimates of asset lifetimes are critical—not for book value or 
depreciation, but for estimating the CFROI itself (see Chapter 25).

474  Measuring Performance in Capital-Light Businesses
assessments, resource allocation, and competitive behavior. For instance, if the 
cost of capital is 10 percent, PharmaCo is in fact destroying value, and man-
agement should question continued investment. Competitors should question 
the validity of entering the company’s product markets. The margins may be 
high, but required investments in R&D are large.
To illustrate the impact of capitalizing intangibles on estimates of ROIC and 
perspectives on value creation, we analyzed past spending on research and 
advertising over a ten-year period for four global companies in branded con-
sumer goods. After the estimated past expenses in R&D and advertising were 
capitalized and amortized, ROIC for all companies decreased significantly 
and also provided a very different ranking of performance, as shown in the 
top portion of Exhibit 24.7. A similar analysis of ROIC including capitalized 
EXHIBIT 24.7  Impact of Adjusting ROIC for Intangible Investments
%
ROIC
ROIC adjusted for intangible investments
61
21
60
17
45
12
41
15
36
16
9
8
4
3
2
1
Branded-consumer-
goods companies
22
32
131
48
106
25
67
30
53
22
48
15
42
7
7
6
5
4
3
2
1
High-technology companies
6
62