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Economic profit is also referred to as economic value added (EVA), which is a trademarked concept originally devised by Stern Stewart & Co.
The formula for economic profit is:
Economic Profit = Net Operating Profit After Tax - (Capital Invested x WACC)
As shown in the formula, there are three components necessary to solve economic profit: net operating profit after tax (NOPAT), invested capital, and the weighted average cost of capital (WACC).
The net operating profit after tax (NOPAT) can be found on the corporation's income statement, or calculated if preferred.
Capital invested is the amount of money used to fund a particular project. We will also need to calculate the weighted-average cost of capital(WACC) if the information is not already provided.
The purpose of multiplying WACC and capital investment is to assess a charge for using the invested capital. This charge is the amount that investors as a group need to make their investment worthwhile.
Let's take a look at an example.
Assume that Company XYZ has the following components to use in the economic profit formula:
NOPAT = $3,380,000Capital Investment = $1,300,000WACC = .056 or 5.60%
Economic Profit = $3,380,000 - ($1,300,000 x .056) = $3,307,200
The positive number tells us that Company XYZ more than covered its cost of capital. A negative number indicates that the project did not make enough profit to cover the cost of doing business.
