Return on Risk-Adjusted Capital (RORAC) is a financial metric used to assess the profitability of an investment or business activity relative to the amount of capital at risk. It is a measure that takes into account both the potential returns and the level of risk involved in an investment.
RORAC incorporates the concept of risk-adjustment, which means that it considers the amount of capital required to support a particular level of risk. By factoring in the risk associated with an investment, RORAC provides a more accurate measure of its profitability compared to simply looking at the raw return on investment.
The calculation of RORAC involves dividing the expected return from an investment by the capital at risk. The expected return is usually estimated based on factors such as projectedw cash flows, interest rates, and market conditions. The capital at risk represents the amount of capital that would be lost if the investment performs poorly.
RORAC is often used by financial institutions and investors to evaluate the profitability and riskiness of different investment opportunities. It helps them make informed decisions by comparing the potential returns of various investments while considering the associated risks. A higher RORAC indicates a more favorable risk-return trade-off, suggesting that the investment is more efficient in generating returns relative to the amount of capital at risk.
Overall, RORAC serves as a useful tool for assessing the profitability of investments while considering the inherent risks, allowing investors to make more informed decisions based on a comprehensive understanding of both factors.
