Comment 2: If applied correctly, the NPV of this project will be higher if we discount economic profits instead of net after-tax operating cash flows in our analysis. I suggest we calculate economic profit as net operating profit after tax minus the dollar cost of capital. Comment 2 is incorrect. In theory, when discounted at the WACC, the present value of the economic profits from a project equals the NPV of the project. For a given period, economic profit = NOPAT – $WACC, where NOPAT is net operating profit after taxes and $WACC is the dollar cost of the capital used during the period. Economic profit reflects the income earned by all capital providers. i don’t understand the explanatio, what r they talking about. all i did was i said that: net after tax operating cash flow = (S-C-D)(1-T) + D = (EBIT)(1-T) + D EP = NOPAT - $WACC = EBIT(1-T) - $WACC Mathemetically, net operating cash flow will always be larger, so the NPV with NOCF in numerator will be larger. That’s my reasoning for why the statement is false. Am I off here?
One is discounted by the cost of equity and the other by the WACC. I got this one wrong two, and I also think Book 7 is a joke. If I pass level II my new screen name will be book7_isajoke. If I dont then I will spend the summer studying this awesomely hard tome.
You’re forgetting that the depreciation lowers the value of invested capital each year, which lowers the value of the $WACC element over time, so that each successive year, you’re subtracting a lower $WACC from EBIT(1-tax rate). So they do equal each other.
relision, could you elaborate please? i understand that the depreciation will lower the $wacc each year, which means that each year the EP is larger. so what? how does that make them equal? also, i thought theyre both discounted at wacc. EP definitely is, and with operating cash flow, its ebit so im 99% sure u discuont by wacc as well.
oh thing to note when using cash flows to found npv you need to back out initial investment you need to do so because cash flows don’t include depreciation (which is cost of the asset) so you back it out separetely as initial investment with economic profit you don’t need to because your EP does not back out depreciation so cost of asset is included. See page 37 of book 3 vs. page 39 in schwesser. So while you are correct that cashflows are higher than EP, with cash flows you have initial investment to subtract and with EP you don’t.
study notes book 3, when they introduced the concept of RI, EVA and claim of valuation they noted sth like this: if applied correctly all 3 methods would have the SAME result, when they do have different result, you should review the underlying assumption. to make the mathematical sense out of it, the discount rates for each methods are different. ignore the explaination, I didin’t understand the explaination either