The weighted average cost of capital for a company is 12 per cent and the firm achieved an operating profit before interest and tax of £1.5m in the latest year. The company started the year with £20m of invested capital. What was the economic profit?
A) - £900,000
B) £900,000
C) £3.7m
D) £2.4m

Question

Quizplus · Accepted Answer

Economic profit is calculated as the operating profit after tax minus the capital charge (the amount of invested capital multiplied by the weighted average cost of capital). Assuming no taxes for simplicity, the capital charge is £20m * 12% = £2.4m. The operating profit is £1.5m. Therefore, the economic profit is £1.5m - £2.4m = -£900,000.

The Weighted Average Cost of Capital for a Company Is