On Schweser book 2 p.242, under the capital budgeting section, they mention that Economic profit is NOPAT - $WAAC (which is the formula for the EVA).
Then, on the third book p. 226, under the RI valuation chapter, they start by saying that "Residual income, or economic profit, is net income less a carge measuring stockholders opportunity cost of capital.
This is very confusing. Can anyone clarify?
I think the “economic profit” in the book 3 wants to be a synonym of residual income, not exactly the EVA (economic profit) of the book 2.
If you look well, both approaches are very similar (both are excess returns). The difference is that RI is only for stockholders (as the book 3 clearly says), while EVA (“economic profit” of book2) is for stockholders + debtholders. Just that.
Yeah, i know.
But what if they ask us to calculate economic profit. Which should I use? Or will the questions CLEARLY state whether its RI or EVA they are looking for?
I think the exam will be clear. Like L1 exam I found no confusing questions nor leading wording.
If they ask you for economic profit (EVA), use NOPAT - $WACC
If they ask you for residual income, use NI - Equity Charge
If they ask you for economic income, use EBIT(t-1) - economic depreciation
Regarding economic income ; isn’t that after tax operating cfs. EBIT(1-t)+Depreciation
after tax cash flow = EBIT(1-t) + Dep + Deferred Taxes
eg : 4 year proejct
EI year 3 = CF - ED
where CF --> AT OCF year 3 = EBIT (1-t) + D
ED = Beginning MV - Ending MV
Right, forgot to add the Depreciation.
Thanks.
I had the same question as andrevc and the answers make me more confusing :(.
is Economic Profit = Residual Income as stated in Curriculum, book 4 page 463 or in schweser 3, page 200?
Is EVA is equal to Economic Profit (the two are calculated by formula EBIT*(1-tax rate) - $WACC ) as stated in Curriculum book 4 page 464 and in Curriculum book 3 page 61? Attention, the two are calculated with WACC, so the two are for debtholder+shareholder.
schweser book 3 page 202 says Residual Income and EVA are both measuring Economic Income, and that “RI and EVA are different in calculation” (attention, in calculation. Schweser doesnt say the difference is in value). So, can I deduce that RI is equal to EVA?
With three points, can we say RI=EVA=Economic Profit?
In addition, from the third point, RI and EVA are “both measuring Economic Income”. But the Economic Income is calculated by the formula cashflow -depreciation ( in Curriculum book 3 page 58) which is completely different to the formula of EVA (or economic Profit). So, RI and EVA are both measuring Economic Income but calculated differently to Economic Income!!! It makes me confusing :-(.
Can someone help me? 
Agree, it’s not fully clear how all 3 NPV’s are the same.
Econ Income & RI are discounted at cost of equity, Econ Profit is discounted at wacc.
I think RI = EP because,
2.1. The Use of Residual Income in Equity Valuation
Residual income and residual income models have been referred to by a variety of names. Residual income has sometimes been called economic profit because it is an estimate of the profit of the company after deducting the cost of all capital: debt and equity. In forecasting future residual income, the term abnormal earnings is also used.
2.2. Commercial Implementations
One example of several competing commercial implementations of the residual income concept is economic value added (EVA).8
-> EVA is a trademarked application of EP. However, because of the adjustments made in calculating EVA, a different numerical result will be obtained , in general, than that resulting from the use of the simple computation presented in Example 1.
As confirmed by Harrogath (he wrote Economic Profit = EVA) and by castintosee (he confirmed RI=Economic Profit), can we say RI = EVA = Economic Profit as I wrote
In addition, are you agree with me that NOPAT - $WACC = NI - Equity Charge
(NOPAT = NI + AfterTaxInterestExpense => NOPAT - $WACC = NI + AfterTaxInterestExpense - ( AfterTaxInterestExpense + EquityCharge) = NI - EquityCharge )