Corp Fin and Equity RI and economic profit

CFA Level II
#1

has anyone got an easy way to keep these related but differant concepts clear.

all have so far is the following

Residual income is called RI in Corp Fin but RI or econ profit in equity

They are calculated the same way except corp fin uses NI and equity uses EPS

they both calculate the equity chrge using the same rate r and both multiply this rate by open BV

Equity has a modified version that uses ROE-r to determine econ profit

Corp fin also has a modified version they call econ profit. Here you subtract your equity charge not from EPS or NI as done for RI but from NOPAT and you don’t use r but WACC as the multiplier against open BV

#2

Equity charge is not subtracted from NOPAT but $WACC is subtracted which is the capital charge.

There are two ways to approach to RI

  1. Net Income - Equity Charge

  2. Net Operating Profit After tax - Capital Charge

If you use NI then you are calculating total Residual Income or Economic Profit which is more than normal as Normal profit = Equity charge.

EPS is used to calculate Residual Income per share as the Residual Income model is used to calculate value of the stock so they both are same things just divided by no. of shares outstanding.

ROE = NI/BV

NI = ROE x BV

RI = NI - rBV

RI = ROE x BV -rBV

RI = BV(ROE - r)

They above equation is derived from first approach and it is the same thing.

I think you’ll be comfortable with all of them soon.

#3

Thanks i did mean to say capital charge but other than the chnage from r to WACC its the same thing. I found the real estate material confusing until i realised that in one area they just used the GGM but change some of the names of the terms. Also was sad to see how totaly outdated the text was. its from 2002 and the real estate market has chnaged quite a bit since then

#4

Exactly. I agree with you…