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CFROI (cash flow return on investment) is an indicator of a firm’s ability to create value. Technically, CFROI is the average level of internal profitability that is equal to a firm’s economic assets, taken as a gross total (i.e. before depreciation costs) and adjusted for inflation, and the series of gross surpluses after tax, calculated over the lifetime of fixed assets. The last of these is estimated by dividing the gross value of capital assets by the year’s depreciation costs. Compared to the average weighted capital cost, CFROI enables to calculate the extent to which a firm’s cash flows are superior to its cost of capital.
The CFROI is also a means of assessment if one assumes that a company’s cash flows are a better indicator than its earnings (the price/earnings ratio), which are often subject to accounting distortions. It is used to compare the economic profitability of a firm to that of its peers, and its variation from one year to another gives an indication of its development. It is also interesting to establish a relationship between the CFROI and a firm’s share value. For example, if an investor believes that the heightened CFROI of a firm is badly reflected by its share price, they will exploit this assessment anomaly by betting on a rising share price.