Corporate Finance

[haiderraza]

Economic Profit is NOPAT - $WACC.
1) My point is - In arriving at NOPAT, we have already deducted interest expense. In $WACC, both equity and debt cost of capital are factored in which imply that we are deducting these both. Interest expense is actually cost of debt which has already been deducted. So, why are we deducting this again in $WACC?
2) Pls tell me the concept behing economic profit. What is is exactly?

 

[haiderraza]

Residual Income = Net Income - (equity charge x beginning value of equity)
Somebody pls explain the concept of this

 

[cpk123]

What would equity charge mean to you? To me it is the cost that you pay for having equity on your books - which would mean - similar to interest expense (that you pay on your debt) - you pay a dividend to your equity holders.
You pay that dividend on your beginning of period equity.
So Equity Charge * Beginning Value of Equity = Dividends.
Net Income Less Dividends paid = Residual Income.
And since you have already removed Interest Expense when you arrived at Net Income - you now have “residual income” - all available for you to grow your company.

 

[haiderraza]

thanks cpk123. Plese elaborate my first question aslo about economic profit.

 

[geo]

haiderraza wrote:
Economic Profit is NOPAT - $WACC.
1) My point is - In arriving at NOPAT, we have already deducted interest expense. In $WACC, both equity and debt cost of capital are factored in which imply that we are deducting these both. Interest expense is actually cost of debt which has already been deducted. So, why are we deducting this again in $WACC?
2) Pls tell me the concept behing economic profit. What is is exactly?

You haven’t deducted your debt cost in NOPAT. Its net OPERATING profit, after tax. Operating profit does not include interest expense.
Hope that helps.