Quick Q on Econ Profit and RI always, economic, reference, capital

Maddin

Is Residual Income the same thing as Economic Profit?
I’ve always thought Econ Profit as EVA but in Schweser book 3 page 274 the first sentence it says:
“Residual Income (RI), or economic profit, is the net income of a firm less a chrrge that measurs stockholders’ opportuity cost of capital. ”
and… no other reference about economic profit. (I dont have the CFAI book with me atm but will check on it when I do have it).

Analti_Calte

They are different.
Economic Profit=NOPAT-$WACC
The $ WACC=(WACC)(Capital)
The RI is RI=NI-Equity Charge
The equity charge=(rce)(capital)

HuskyGrad2010

It depends on how the WACC is calculated, if the cost of debt used to calculate WACC is the same as the rate that will provide the interest expense on the income statement EVA and RI should be equal. But since that isn’t always the case, don’t assume they will be the same for the test.

dmrktrading

bhans2 Wrote:
——————————————————-
It depends on how the WACC is calculated, if the
cost of debt used to calculate WACC is the same as
the rate that will provide the interest expense on
the income statement EVA and RI should be equal.
But since that isn’t always the case, don’t assume
they will be the same for the test.
Dude, what are you talking about? WACC and required return on equity are calculated differently.

strikethree

RI = NI - (BV of equity * Re)
EVA = EBIT(1-t) - $WACC
(EBIT)(1-t) - Interest(1-t) = NI
$WACC = (cost of debt * total debt)(1-t) + (Re * BV of equity)
Therefore, if (Cost of debt * Total Debt)(1-t) = Interest Expense(1-t) then
RI = (EBIT(1-t) - Interest Expense(1-t)) - (Re * BV of equity) and
EVA = EBIT(1-t) - (Interest Expense(1-t) + (Re * BV of equity))
And
(EBIT(1-t) - Interest Expense(1-t)) - (Re * BV of equity) = EBIT(1-t) - (Interest Expense(1-t) + (Re * BV of equity))
For example if EBIT(1-t)=5, Interest Expense(1-t)=2, and (Re * BV of equity)=1
(5 - 2) - 1 = 2 and
5 - (2 + 1) = 2
Therefore, if (Cost of debt * Total Debt)(1-t) = Interest Expense(1-t) then
EVA = RI