Value Creation Revisited: The Economic Profit

Abstract

This short paper studies the Economic Profit, a different label for the Economic Value Added, EVA. Copeland et al. (1995) show that the present value of the free cash flow and the present value of EVA (Market Value Added MVA) are not the same, unless the present value of future EVA (they call it economic profit) be added to the initial capital invested. This present value includes, in both of them, the continuing value, which is the present value of the perpetuity for the cash flow and for the economic profit. For both of them, they end up with the Entity Value and the Equity Value. They present an extensive example and it will be analyzed in this paper. In that example they show that both, Entity and Equity Value are the same when calculated through the free cash flow or the economic profit. In this paper that assertion is examined in detail. It will be shown with the same example presented by them, that it holds true only under very restrictive assumptions. This is, when WACC assumes a given value.

JEL Classification: M40, M46, M41, G12, G31, J33