# compare net operating profit after taxes as a percentage of its total assets can be compared with WACC

I am talking about reading 37 question 5, the question says to decide a company’s residual income above or below 0, it can compare net operating profit after taxes as a percentage of its total assets can be compared with its weighted average cost of capital (WACC).

where.on.earth.is.this.from??

I did the old fashioned Operating profit after tax -interest(1-t)-equity charge, but can someone help me understand the rational of the original question?

BUMP anyone?

Residual Income and economic profit are linked. One is from the only-equity perspective and the latter is from the whole-firm perspective.

You can also calculate RI from those numbers. I will show.

EBIT*(1-t) = 10

EBIT = 10 / (1 - 0.40) = 16.67

Assets = 100 >>>> 50% financed with debt

Debt = 50 anb Equity = 50

Pretax cost of debt = 9%, so interest expense is 50 * 9% = 4.5

I’m looking for Net Income:

EBT = 16.67 - 4.5 = 12.17

Taxes = 12.17 * 40% = 4.87

Net Income = 12.17 - 4.87 = 7.3

Cost of equity = 12%

Residual Income = 7.3 - 50 * 12% = 1.3 (positive RI)

Hope this helps!

Good question. It shows you that the % of return on net operating profit after tax above the WACC is the % RI.