Q35 R29 - economic profit economic, interest, invested, bearing

slackeranalyst

CFAI answer seems wrong to me. Not sure where or how to report this mistake.
Economic Profit Question.
Company has $200,000 in Assets, $122,027 liabilities, $77,973 Shareholders Equity. EBIT is $30,000. Tax Rate of 40%. WACC given as 12%.
Problem specifically says, “Debt/Capital ratio is 50%.” Therefore, interest bearing debt is assumed to be $77,973 and total invested capital is $77,973 * 2 or $155,946.
EP = NOPAT - $WACC
NOPAT is $30,000 * (1 - 0.40) = $18,000. I get the same result as CFAI, no quarrel here.
$WACC. CFAI says to take 12% (WACC) * $200,000 (Total Asset Value) = 24,000
Therefore EP = $18,000 - $24,000 or -6,000. Answer B.
In the real world of finance (ie. the non-textbook retarded CFAI viewpoint) and based on my experience the right way to calculate $WACC is:
12% * $155,946 = $18,713.52
You only take the WACC % off the capital that is assumed to be interest bearing or have a required rate of return. Other liabilities are assumed to be things like accounts payable which do not carry a cost of capital. It’s the whole reason business models like Dell or Amazon.com (which pay their suppliers after receiving payment and have negative days working capital) are attractive because they are effectively getting 0% interest free loans to finance their business and that improves their economic profit.
So the REAL EP in this problem should be = $18,000 - $18,713.52 or -$713.52
Thoughts?

jbaldyga

Ya i got ya there just misread your info
Debt/Value… Thats pretty vague alright, but you would have to assume its debt/equity value. Debt/value is more commonly used in mortgagae markets, as in your loan/value ratio.

ASSet_MANagemen

”Problem specifically says, “Debt/Capital ratio is 50%.” Therefore, interest bearing debt is assumed to be $77,973 and total invested capital is $77,973 * 2 or $155,946.”
I dont get why you multiple by two, I understand that debt/capital is 50% but the liabilities figure may include other liabilities besides debt. I agree with your other point though about the dollor wacc using assets.
Sry mis read your info

zephyranalyst

I’ve passed through this kind of question on several mocks (CFAI and Schweser) and that’s how its calculated. They multiply WACC by total assets. On 1 example, total assets = total fixed assets which is the only asset number given. They ask to calculate EP for year two where they’d deduct depreciation from fixed asset and multiply it by WACC.
Now if you think that their solution is retarded, then wait till you get to to the mock exams =)