Page 67: the chart shows that with an appreciating currency, interest coverage ratio is lower under all current and higher under temporal. EBIT and int are both NI figures so they should both be average, no? Page 114: 3 bullet points on when to use FCF model. third one says “the firm is a takeover target (because FCF models take a control perspective.” now i know that a control perspective means you use FCF model, but if youre a takeover TARGET, do you have a control perspective? i feel like this should have said “if youre an acquirer”, not the target Page 121: “Residual Income = Economic Profit”. No no no no no no no this can’t be right. EP =EVA = NOPAT - $WACC is what I have branded into my brain. Residual income = NI - equity charge. Please tell me they’re wrong.
The NPV of using capital budgeting, EP, or RI are the same.
For your first question, you need to focus on the COGS and how that changes with an appreciating currency under both methods (they’re right). For number two, it’s pure semantics, but again, I’d say that they’re right. For number three, I looked at page 121, and I don’t see where it says that.
for number 3 i thought there are diff versions of economic profit. RI, EVA & MVA are all diff ways of accounting for economic profit
right but they are not writing the npv of economic profit doesnt at the wacc and the npv of residiual income discounted at the cost of equity are the same. they write EP = RI
skillinoare its the first line of page 121
67 - EBIT and NI are average in current method, but in temporal method, COGS is technically historical (unless goods were sold evenly thru the yr in which case its average). Depreciation is also historical under temporal. That means that EBIT/interest (coverage) will be lower under temporal because EBIT is lower because COGS+depreciation was lower because lower historical rate was used and currency is appreciating . hmmm that sounds right to me but I think I just contradicted what you’re saying that secret sauce is saying. 114 - its fine, it means “if you’re an acquirer and the firm you’re valuing is a take over target, then use FCF”. you dont use it to value your own firm. actually why would you want to value your own firm anyway, you’d already know everything about it and more. 121 - remember what you have branded into your brain, its correct. i think the relationship they mention is also correct as i remember someone giving a proof for it on this forum, but i cant remember the details.
121 is right net income is after interest therefore already taken into account debt charge: so RI = NET INCOME - EQUITY CHARGE NOPAT is just EBIA AKA earnings before interest but after tax, so hasn’t taken into account interest yet. They account for the interest charger in the WACC so EP=EVA=RI
for number 3 assuming: (1) Int Exp/Debt is equal to the cost of debt, and (2) the weights of Debt and Equity are the BV weights; then they are exactly the same thing EPorEVA=EBITx(1-t)-WACC*TotalCap=NI-Re*TotalEq=RI
the first problem in the book (CFAI text) makes you do the very same thing, and come up with the same conclusion. if the cost of debt used in the WACC calculation = Cost of Interest expense used for the NI Calculation -> NOPAT-$WACC = NI - r*BV or EP=RI