A lot of corporate finance tells us that looking at historic reinvestment rate * ROIC gives us a good indication of how much a company's earnings can grow by.
In this context, I'm trying to look at different approaches to calculating a company's historic rate of reinvesting capital as a percentage of earnings. One of the formulas I've come across is;
Net CapEx + Change in working capital / NOPAT.
I am struggling to conceptualize why we need to add back depreciation in the above formula. To me, gross CapEx alone plus change in WC seems to be the most appropriate approach since it reflects the actual amount of cash investment that a firm has had to reinvest.
In a simple example....
NOPAT - $100m
Depreciation - $20m
CapEx - $20m
assume no change in WC
According to the conventional formula, the company has not reinvested anything, which is clearly not the case. If it's reinvested the same amount of CapEx to cover its depreciating assets then while the company won't necessarily grow, that $20m CapEx is still a reinvestment required to sustain the existing level of business operations. To me, the reinvestment rate is 20%.
The only way that I can see this formula working is that the reinvestment rate is implicitly defined solely as any capital that's reinvested into the business over and above the level of reinvestment required simply to maintain the existing business. But I haven't found any explicit definition to say that's the case, which is a bit confusing. By 'reinvestment rate' does this actually mean reinvestment 'over and above' investment in existing assets? In which case 'growth reinvestment rate' would perhaps be a more suitable title?