Question

When calculating economic profit using the 'performance spread' method, the invested capital is subtracted from the performance spread to economic profit. Which of the following shows how performance spread is calculated?

A) Return on capital + WACC
B) WACC - Return on capital
C) Entity value - WACC
D) Return on capital - WACC

D

Accepted Answer

The performance spread is calculated as the difference between the return on capital and the weighted average cost of capital (WACC). Therefore, the correct formula is Return on capital - WACC. Choice A is incorrect because it adds the return on capital and WACC instead of subtracting them. Choice B is incorrect because it subtracts the return on capital from WACC instead of subtracting WACC from the return on capital. Choice C is incorrect because it subtracts the WACC from entity value, which is not the same as performance spread.

Deck 9: Stock Markets