EP in corp. finance vs RI in equity discounted, investment, different, required, finance

ba736

Econ. profit=NOPAT-$WACC; discounted at WACC
One approach to calculate residual income in equity (p583):
RI=NOPAT-captial charge (debt charge +equity charge); discounted at required rate of return on equity investment.
It looks the same concept to me, but why discounted at different rates?

spreads

RI uses NI, not NOPAT.

jarobi04

piwanowi Wrote:
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> RI uses NI, not NOPAT.

Please check the equity curriculum at p583 Approach 2.
get the same results from NI and NOPAT.

5566

NOPAT = EBIT(1-t) which doesn't adjust for interest expense. Also EVA = NOPAT - $WACC which again accounts for profit generated after tax after contributions from all capital sources, debt and equity.

RI model looks at just excess equity returns. Since RI uses Book Value (assets net of liabilities) only an equity measure of profit must be used, hence Net Income over NOPAT.
RI = Net Income - (required return on equity x B(t-1))

The only time NI and NOPAT would be the same is if the company is financed 100% through equity. Then EVA and RI would give the same results.

ap0258

RI = NI - rB_t-1 So Net Income - cost of equity*last years book value

EP = NOPAT -$WACC

NOPAT is EBIT(1-t). EBIT(1-t) should equal NI.. as long as there is no interest charges on the income statement. If there are, then your calc should be EP = EBT(1-t) - $WACC

note ($WACC = D+E * WACC) which is the weighted average cost of debt (reduced by tax rate), preferred debt (maybe - but not reduced by tax rate) and equity (drived from CAPM).

Houjichasan

If I remember correctly,

r = return on equity
S/E = shareholder's equity BV

RI = NI - (r)(S/E)

EP = EBIT(1-t) - (wacc)(invested capital)


Very different equations, though similar conceptually.

ayaz_mahmud369

still confused. let pay with some numbers
total asset $200, financed with 50% of debt and 50% of equity
total debt $100, cost of debt 7%, tax rate 30%, after tax cost of debt 4.9%
equity $100, cost of equity 12%
EBIT=$40 in the income statement

NI=(EBIT-interest)*(1-tax rate)=(40-100*0.07)*0.7=23.1
RI=NI-rB=23.1-0.12*100=11.1

NOPAT=EBIT*(1-tax rate)=40*0.7=28
WACC=0.5*4.9+0.5*12=8.45%
EP=NOPAT-WACC*invested capital=28-200*0.0845=28-16.9=11.1

it is not 100% financed through equity but still get the same result.
Where did I get it wrong?

eoin

In equity EOC, they say calculate EVA or RI, meaning they are the same. However, in corp finance, they are not the same. EVA in corp finance is EP, which is different from RI. I think that's what the question is.