Economic Profit - why dollar value of WACC is ammortized

CFA Level II Equities
#1

Hi guys,

When calculating the Economic Profit, which is equal to NOPLAT(1-T) - $WACC, the dollar wacc is ammortized due to the depreciation from one year to another. Depreciation is a pure accounting procedure, which doesn’t really relate to the economic benefits or losses. I don’t really understand the concept, thus.

Can you shade some light on this?

Thanks!

#2

The $wacc is a form of capital charge. Ie the return that providers of capital (debt and equity) require on their investment. Once you take it off, the ‘leftover’ profits are the EVA.

#3

When they use the word “economic” here, it is not because you are using purely economic figures. As you stated, accounting figures, such as depreciation, is ultimately factored in too. It is confusing, but the “economic” concept here is in that it actually recognizes the cost of equity capital in the measurement of income, unlike an accounting net income, which would only factor in interest expense (cost of debt). Thus, it is an economic measure to equity holders. That is how I am interpreting it, anyway.

#4

Thanks skwak, this sounds reasonable.

#5

btw, it is not nopat*（1-t) but ebit*(1-t)