Question

3. Explain the difference between ROICs excluding and ROICs including goodwill for U.S. companies: what does this difference imply and why has it increased so much over the past decades?

Answer 1

Goodwill is an item on the balance sheet on the asset side which captures the premium paid by the acquiring company for acquisition of assets of an acquired company. Since this is extra money paid over the fair value of the acquired company, it does not add to productive asset.

So return on invested capital without goodwill is higher than return on invested capital with good will. The difference between the two returns has increased largely because companies have been willing to pay a large premium for acquisitions in the hope that resulting synergies will provide them with large gains. Thus the return on invested capital with good will has come down as compared to return on invested capital without goodwill because of the premium paid on acquisitions.