EBIT(1-t) for RI calculation

CFA Level II Equities
#1

Hope I’m not getting annoying with all the questions, but I wasn’t able to find answers for these.

We can use EBIT to find a residual income for the firm. When we take the effect of taxes out, we don’t account for the tax shield, so we’re acting like the interest is also getting taxed. This makes sense because that money is available to the firm, which includes bondholders. But then for WACC we do consider the tax shield for the cost of equity.

I figured NI + interest expense should have been the same thing as EBIT(1-t), but they’re not. Why can’t we use NI plus interest?

#2

By tax shield here, you mean specifically the tax shield on interest expense?

In the WACC calculation, there is no tax shield for the cost of equity.

NI plus interest will overestimate operating income, because you’re including the tax shield from interest without paying it. So to get to NOPAT, you either add back Interest(1-t), or multiply the EBIT by (1-t)