Page 15 - FINAL CFA II SLIDES JUNE 2019 DAY 6
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Economic income = cash flow + (ending market value − beginning market value)
Or = cash flow − economic depreciation READING 20: CAPITAL BUDGETING
where: economic depreciation = (beginning market value − ending market value)
MODULE 20.3: REAL OPTIONS AND PITFALLS IN CAPITAL BUDGETING
Calculate economic income:
The beginning market value = initial investment + NPV of investment
= $400,000 + $168,467 = $568,467. Calculate accounting income:
Interest expense is calculated by assuming that Blue Wave finances 50% of the project’s market
value with debt at a pre-tax cost of debt of 6%. Each year, interest expense is equal to 6% of
The economic income rate of return for each year is precisely equal to the beginning market value times 0.5. For example, year 2 interest expense is 6% of ($459,682 ×
project’s WACC. This makes sense because the WACC is the discount 0.5), or $13,790.
rate used to determine the value of the company.
