No. Economic profit is a term from Level 1, where it is the actual profit earned after deducting all the economic expenses, like opportunity cost. I have not seen this term in Level 2. If you mean Economic Income then it = CFAT - Economic deprecitian And, Residual Income = Accounting Income - Book Value of Equity x Required return of equity(Equity Charge) Somebody please re-confirm.
No they are not the same, EP=EVA=Nopat-$WACC, this is discounted at WACC RI=(ROE-r)BV=EPS-rBV, this is discounted at r.
YES. They are the same ONLY if the debt structure in invested capital represents the same debt used in WACC
What I mean by the above statement is that if interest expense reflects the same interest in WACC in its debt proportion as a total percentage of assets in terms of book value, then RI will equal Economic Profit.
Can anyone confirm what Aliman is saying? I am starting to think that EP will be higher than RI because EP will be value added (net of opp cost) to all capital providers and RI will be value added (net of opp cost) for to equity providers. Therefore I’m thinking that EP > RI all else equal
Here are my thoughts on it. EP = NOPAT - $WACC RI = Earnings(t) - rBV(t-1) The questions is if EP = RI Expanded … EP = RI NOPAT - $WACC = E(t) - rBV(t-1) EBIT(1-tax) - (WACC)(Tot Cap) = Earnings(t) - (Equity Charge)(BV)(t-1) The left side has a total capital approach where a blended charge on debt and equity (book value) is removed from earnings. (Earnings available to all cap providers since interest is still in there.) The right side is after-interest earnings less an equity charge on book value. These two might be a lot closer in an all equity company, to take an extreme. But it seems like you’d still have a problem with comparability between Total Capital and BV of Equity. Maybe in theory you would discount all Liabs as debt, leaving only Assets and Equity. Might be a stretch … Interesting question.
Yes. RI can sometimes be reffered to as EP because it represents the economic profit of the company after deducting the cost of all capital.
I’d say YES too. In RI, you start with Net Income, which has already accounted for Debt Charges through Interest Expense, and you deduct an Equity Charge… You have measured profits after considering both Debt & Equity Charges… In EVA, you do the same, you take EBIT(1-T), both you deduct the Debt & Equity charges at the same time using Total Capital… Using both methods, you get economic profits… = what remains after accounting for Debt & Equity charges…
Good Point Vince. NI deducts the Rd * (Debt) portion of $WACC, so when we deduct Re * (Equity) we end up up with the same thing as NOPAT-$WACC.
In CFAI reading 45, there are a few examples where you calculate EVA vs RI and they come out the same. They state that “EVA is a commercial implementation of the RI concept”. However, as others have noted, there can be variances due to different accounting adjustments made under the two methods. "Because of the adjustments made under the EVA " (for example, inventory LIFO reserves, deferred taxes, capitalization rather than expensing of certain items) "a different numerical result will be obtained, in general, than that resulting from the use of the simple computation " of residual income.