does cost of capital equial returied rate of return on equity capital ? I see sometimes they refer the same thing when calculate residuel income why required return drop will drop EVA? in the formula EVA=NOPAT-$WACC, a drop in required return on capital drop $WACC, increase EVA… Thanks.
WACC (cost of capital) is different from required rate of return on equity or cost of equity. I think in the residual income equation “r” is cost of equity, i could be wrong though. Second question- if WACC decreases, then yes that $WACC (or dollar cost of capital) goes down, so you are subtracting a lower number, so EVA goes up. Does this make sense?
the EVA question is from a text book questio, I will find it out. When required return on capital drop, it drops EVA. that why I don’t understand… AndrewUNH Wrote: ------------------------------------------------------- > WACC (cost of capital) is different from required > rate of return on equity or cost of equity. I > think in the residual income equation “r” is cost > of equity, i could be wrong though. > > Second question- if WACC decreases, then yes that > $WACC (or dollar cost of capital) goes down, so > you are subtracting a lower number, so EVA goes > up. Does this make sense?
Cost of Capital is WACC which includes a component of debt and a component of equity, hence r (cost of equity) is a component of WACC EVA=NOPAT-$WACC After you have your operating profits from all deductions necessary pre interest expense, in this case (NOPAT) you take out the portion of the cost of providers of capital (both debt and equity) in this case expressed in terms of WACC, anything left over after paying off your Equity and Debt is considered Value added (EVA) If you r decrease, it will decrease your WACC so you don’t need to pay equity holders as much as you did before, hence your residual added value (EVA) after paying off capital providers goes up.
NOPAT-WACC=EVA