What is the difference between return on equity and return on capital?
Return on capital essentially is the same formula as return on equity, but with the addition of one component. Return on capital, in addition to using the value of ownership interests in a company, also includes the total value of debts owed by the company in the form of loans and bonds.
For example, if the company in the first example also owed $100 million in debts, the return on capital would drop to 1% ($2 million divided by the sum of $100 million in equity and $100 million in debts).
Both measures are well-known and trusted benchmarks used by investors and institutions to decide between competing investment options. All other things being equal, most seasoned investors would choose to invest in a company with a higher ROE and ROC.