Cashflow Return on Investment

The aim of this technique is to minimise accounting distortions (depreciations, inflation, amortisations etc) in measuring a firm’s economic performance. CFROI attempts to measure the expected return on an investment using its cash flows without any adjustments and accounting for the time value of money over a specific time horizon.

Damodaran describes the techniques as the modified Internal Rate of Return for investments that have already been made.

The CFROI is calculated by taking the IRR between:

1. the gross investment which is the asset value grossed up for accumulated depreciation and the current dollar adjustment ,
2. the gross cash flows which is the cash flows without depreciation and amortisation and with adjustments for operating leases and other accounting effects;

To enhance its value into the future the firm then needs to increase the spread (or difference) between the CFROI and the WACC

Key benefits of this technique is:

1. It provides a valuation technique that concentrates on its economic performance and removes the benefits created sorely by intelligent accounting techniques;
2. It is useful technique for measuring the return from investments that have already been made or where is there is large depreciation wedge particularly when investments are replaced before their scheduled time horizon.