When CFROI Equals IRR  485
When ROIC is constant, the asset provides a constant return over the ini-
tial investment, net of recovering the initial investment itself. Therefore, this 
return must also equal the IRR of the cash flows for the asset, or 15 percent. 
More precisely, the investment’s ROIC equals the IRR if the earnings gener-
ated from the investment are proportional to the invested capital, net of ac-
cumulated depreciation, in each year of the investment’s lifetime.
It is possible to generalize the result for a business consisting of a portfolio 
of five of these individual assets, which have remaining lifetimes of one, two, 
three, four, and five years, respectively (see the rightmost column in Exhibit 
25.1). For this business, the operating cash flow, profit, and invested capital are 
a straightforward sum of the operating cash flow, profit, and invested capital 
for each year of the individual asset’s lifetime (for example, operating cash 
flows for the business equal $35 + $32 + $29 + $26 + $23 = $145). What holds 
for the assets will therefore also hold for the business as a whole, so its ROIC 
must equal an individual asset’s ROIC and IRR of 15 percent. If this business 
wants to grow its earnings by, say, 10 percent, it will need to expand its net 
invested capital by 10 percent as well—requiring an investment outlay of $30 
in this case. The IRR on that incremental investment for carbon-copy growth 
equals exactly the business’s ROIC of 15 percent.
This means that the ROIC of a business (or company) is equal to the IRR 
of new investments if the operating earnings for the business are proportional 
to net invested capital.1 In these conditions, ROIC is a value-based measure of 
return on capital, even though it is based on accounting measures of earnings 
and capital.
When CFROI Equals IRR
CFROI is an alternative measure of return on capital based on cash flow rather 
than profit and book value.2 For any given year, CFROI is defined as the dis-
count rate for which the present value of that year’s operating cash flow (as 
an N-year annuity) equals gross invested capital at the beginning of the year, 
where N is the lifetime of the underlying asset. The basic formula for calculat-
ing CFROI in a given year T is
GIC
OCF
CFROI
T
T
t
t
N
=
+
=∑(
)
1
1
where   GICT = gross invested capital at the beginning of year T
OCFT = operating cash flow in year T
1 The same logic underlies the value driver formula introduced in Chapter 3, which showed that DCF 
value increases only for earnings growth at a ROIC above the cost of capital.
2 For more information, see B. Madden, CFROI Valuation: A Total System Approach to Valuing the Firm 
(Oxford: Butterworth-Heinemann, 1999).

486  Alternative Ways to Measure Return on Capital
Any residual value of the asset should be included as an additional cash flow 
for year N and discounted at CFROI.
We illustrate CFROI as an alternative measure of returns by showing finan-
cial projections for an asset whose economics are different from those of the 
prior example. In this case, shown in Exhibit 25.2, the operating cash flows are 
proportional to gross invested capital and constant over the asset’s lifetime, at 
$29 per year. The IRR for the investment is 13.8 percent and exactly equals the 
CFROI, which is constant over the asset’s lifetime. Take, for example, year 2. 
We estimate the asset’s CFROI by solving the following equation:
$
$
(
)
$
(
)
. %
100
29
1
29
1
13 8
1
5
=
+
+…+
+
⇒
=
CFROI
CFROI
CFROI
In fact, when the operating cash flow is constant over an asset’s lifetime, 
CFROI must be equal to the IRR, as follows from the preceding formula. We 
could also say that CFROI equals the IRR of an investment if the operating 
cash flows generated are proportional to the gross invested capital (before ac-
cumulated depreciation).
Let’s generalize the results again to a business consisting of five such in-
dividual assets, with remaining lifetimes of one, two, three, four, and five 
years (the right column in Exhibit 25.2). As in the prior example, the busi-
ness’s overall cash flows, earnings, and invested capital derive from those of 
the underlying five assets. The business’s CFROI and IRR therefore equal the 
CFROI and IRR of each individual asset. If this business wants to grow its cash 
flows by 10 percent, it must expand its gross invested capital by 10 percent as 
EXHIBIT 25.2  Returns When Cash Flows Are Proportional to Gross Invested Capital
$
 
Individual asset
Year
Business of
five assets
 
0
1
2
3
4
5
Operating cash flow
(100)
29
29
29
29
29
145
Depreciation
(20)
(20)
(20)
(20)
(20)
(100)
Operating profit
9
9
9
9
9
45
 
Gross invested capital1
100
100
100
100
100
500
Cumulative depreciation1
–
(20)
(40)
(60)
(80)
(200)
Net invested capital1
100
80
60
40
20
300
IRR, %
13.8
13.8
Cash return on gross invested capital, %
29.0
29.0
29.0
29.0
29.0
29.0
Cash return on net invested capital, %
29.0
36.3
48.3
72.5
145.0
48.3
ROIC, %
9.0
11.3
15.0
22.5
45.0
15.0
CFROI, %
13.8
13.8
13.8
13.8
13.8
13.8
|
|
ROIC increases over asset lifetime.
CFROI is constant over asset lifetime.
ROIC > IRR
CFROI = IRR
1 At beginning of year.