Question 6.3: Explain the shortcomings of return on capital employed as an...
Explain the shortcomings of return on capital employed as an investment appraisal method and suggest reasons why it may be used by managers.
The shortcomings of return on capital employed (ROCE) as an investment appraisal method are: it ignores the time value of money; it ignores the timing of cash flows; it uses accounting profits rather than cash flows and it does not take account of the size of the initial investment. However, ROCE gives an answer as a percentage return, which is a familiar measure of return, and is a simple method to apply. It can be used to compare mutually exclusive projects, and can also indicate whether a project is a ‘good’ one compared to a target ROCE.
For these reasons, it is used quite widely in industry.
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