Page 16 - FINAL CFA II SLIDES JUNE 2019 DAY 6
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LOS 20.i: Distinguish among the economic profit, residual READING 20: CAPITAL BUDGETING
income, and claims valuation models for capital budgeting
and evaluate a capital project using each.
MODULE 20.3: REAL OPTIONS AND PITFALLS IN CAPITAL BUDGETING
Economic profit is a measure of profit in excess of the dollar
cost of capital invested in a project: EXAMPLE: Calculating economic profit: Using the data from our previous
example, calculate the economic profit for Blue Wave in years 1 through 4.
EP = NOPAT − $WACC
where:
Straight line depr
NOPAT = net operating profit after tax = EBIT (1 − tax rate)
$WACC = dollar cost of capital = WACC × capital EBIT (1-t)
Capital = dollar amount of investment 12% * capital
The NPV based on economic profit is called the
market value added (MVA):
Notice that MVA = NPV?
Company value = Project NPV + initial investment = $168,467 + $400,000 = $568,467
Residual income focuses on returns on equity, determined by subtracting an equity charge from the accounting net income.
Calculate the NPV of the Blue Wave project and the company = $168,467, same prior methods!
using the residual income method. Company value = PV of the residual income plus the equity
investment (net worth in year 0) plus the value of debt:
= $168,467 + $115,767 + $284,233 = $568,467
More in-depth in book 3!
