RI and econ profit.

CFA Level II
#1

Just to check… residual income and economic profit are the same?

#2

I don’t think so. RI = Net Income - Equity Charge Economic Income = Cash Flow - (V0 - V1) Economic Profit = NOPAT - WACC Charge This is my current understanding…

#3

EP = EVA, right?

#4

As far as I understand, RI can be either 1) NI - (equity capital x Ke) 2) BV0 x (ROE - Ke) 3) NOPAT - $WACC 3 is the same as economic profit, isn’t it?

#5

Yes, I think EVA is EP. I think!

#6

RI is NOT: NOPAT - $WACC That’s EP or EVA… RI = NI - r x BV0 or (ROE - r) x BV0 Economic Income = Cash Flow + Change in Market Value

#7

Thanks, CFATime… I’m a little confused. In Schweser (I know!), it says that both residual income and EVA are measures of economic profit (p.274)… And then it goes on to say (p.276) to notice the difference in calculation of RI and MVA, but that conceptually they are measuring economic INCOME… WHAT?! Grrrr…

#8

isnt EP value for all holders (debt and equity) and RI is value for only equity holders hence, EP uses WACC and RI uses r

#9

That’s right. Economic income is the only one that can be confusing. The change in market value is the change in the remaining cash flows usually (economic depreciation.)

#10

Thanks folks. Much appreciated!

#11

MVA = NPV of EP or EVA discounted at WACC

#12

CFAtime Wrote: ------------------------------------------------------- > RI is NOT: NOPAT - $WACC CFAtime, Please correct me if I’m wrong, but on p. 582 in Vol. 4 Reading 45 - Residual Income, the CFAI text provides two approaches to calculating RI. The second approach is: RI = NOPAT - Capital Charge where Capital Charge = Equity charge x Debt charge Equity charge = cost of equity x equity capital Debt charge = cost of debt x debt capital x (1-T) How is $WACC different from Capital Charge? I believe they are the same, so RI = NOPAT - $WACC is just another way to calc RI. > > That’s EP or EVA… > > RI = NI - r x BV0 or (ROE - r) x BV0 > > Economic Income = Cash Flow + Change in Market > Value