The Motley Fool Discussion Boards

Previous Page

Investing/Strategies / It's Earnings That Count

URL:  https://boards.fool.com/hewitt-thanks-for-the-detailed-response-your-26430390.aspx

Subject:  Re: Question for Hewitt about WACC Date:  2/29/2008  5:59 PM
Author:  valuemoosie Number:  1443 of 1817

Hewitt,
Thanks for the detailed response.

Your explanation confirms my understanding - that we want to measure the company's ability to generate profits from the capital available to them. I was struggling with why I never see anyone else doing this, and I emailed Prof. Damodaran.

His response was that using book equity is appropriate for determining return on capital, whereas market equity is appropriate for determining cost of capital.

Is it reasonable to use market equity for the WACC - skewing the weighting such that it reflects if the company needed new capital - and book equity for the ROIC calculation?

So, ROIC = NOPAT / Invested Capital
where IC is very tied to book equity and Assets on the BS.

And WACC is derived using market equity.

Then EVA = ROIC - WACC.

It measures their current profits off their current available base, but granted, it then figures whether this is value-added by comparing to what equity would cost them today.

I'm not trying to use a microscope here - depending on the capital structure, this difference in weighting could be very minor - but I would like to have a good fundamental understanding before I start "swagging".

Thanks.
-joe
Copyright 1996-2022 trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us