By Pamela P. Peterson
Corporation functionality and Measures of worth further compares the benefits and drawbacks of such conventional measures of establishment functionality as go back on funding with these of newer functionality measures-economic price further, industry price further, and money movement go back on funding. The authors use 1993 monetary info from Hershey meals company, they usually finish that the usefulness of a style is dependent upon the analyst's objective.
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First, two analysts may apply different formulas and draw different conclusions regarding a firm's relative Second, when applied intemajly to reward management, economic profit is subject to potential manipulation. ^^ Another problem with economic profit is how the cost of capital is calculated: o 2Tte me ofthe CXPM. Most applications of economic profit use a CAPM-basedcost of equity. In the applications prescribed by Stewart (P991), a risk premium of 6 percent is used, which contrasts with the lower '$ee Walbert (1993, p.
LLBecause we are dividing NOPATby capital,the cost of capid does not affect this return. 12 'Illis measure is the spread between the return on capital (that is, NOPAT divided by Hrlvested capital) and the cost of capital (expressed in percentage Items). When multiplied by invested capital, this spread produces the dollar economic profit. 7. The difference between the return on capital and the spread is the cost of capital. The fourth valueadded proxy is the chmge in the market value added. 6, and its change is calculated as described in Chapter 3the sum of the change in the market vdue of equity and the change in the book value of debt m d prekmed stock.
Economic profit is analogous to the net present value of capital I3ln addition to estimating the firm's most recent market value capital components, looking at the capital structure of other f i m s in the industry and considering the trends in the firm's capital structure over time are useful because the capital structure of a firm at a point in time may not reflect the firm's target capital structure. '%e extent of the distortion depends on the relalion between the market vdue of capital and the book value of capital-in other words, the market-to-book value ratio discussed earlier.