Residual Income
Computes a company's residual income: net income minus a charge for the use of equity capital, equal to the capital times the required cost of capital. The idea is that accounting profit doesn't tell the whole story — value is only created when earnings exceed what shareholders could earn elsewhere at the same risk. A positive residual income signals a return above the cost of capital. Enter the net income, the equity capital and the cost of equity.
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Residual Income
Computes a company's residual income: net income minus a charge for the use of equity capital, equal to the capital times the required cost of capital. The idea is that accounting profit doesn't tell the whole story — value is only created when earnings exceed what shareholders could earn elsewhere at the same risk. A positive residual income signals a return above the cost of capital. Enter the net income, the equity capital and the cost of equity.
The profit the accountant doesn't show
A company can show a profit on its books and still be destroying value. How? If the profit it generates is less than shareholders would earn investing the same capital in something else of similar risk. Accounting profit charges for the use of debt, through interest, but treats equity capital as if it were free. Residual income corrects that blindness.
The calculation subtracts from net income a charge for equity capital: how much capital shareholders put in, times the return they require. Only what's left is real value creation. A positive residual income means the company earned above its cost of capital; negative means it destroyed value even while looking profitable on the statement. It's the same logic behind EVA.
Enter the net income, the equity capital employed and the cost of equity as a percentage. The tool returns the residual income and tells you whether the company came in above or below the cost of capital. The sensitive point is the cost of equity, usually drawn from the CAPM or a risk-premium estimate, so it's worth testing different assumptions.
Related Tools
Cost of Equity (Bond Yield Plus Premium)
Estimates the cost of equity using the bond yield plus risk premium method: it adds to the company's own long-term debt yield a risk premium for the gap between stocks and bonds. It's a quick alternative to the CAPM, useful when you lack a reliable beta: if the company pays 8% on its debt and the typical equity-over-debt premium is 4%, the cost of equity comes to around 12%. Enter the debt yield and the risk premium.
Market Value Added (MVA)
Computes the Market Value Added (MVA): the difference between a company's total market value and the capital investors put into it. It measures how much wealth management has created (or destroyed) above the money invested — a positive MVA means the market values the company at more than it cost to build. It's the long-run counterpart of EVA, which measures value creation year by year. Enter the market value and the invested capital.
Cost of Preferred Stock
Computes the cost of capital of a preferred stock: the fixed annual dividend divided by the stock's market price, as a percentage. Since preferred stock usually pays a constant dividend, it behaves like a perpetuity, and its cost is the yield on that dividend. This figure goes into the WACC calculation as the cost of the preferred-capital slice. Enter the annual dividend and the preferred stock's price.
The results provided by this tool are for general informational and educational purposes only and do not constitute professional, financial, medical, legal, tax or accounting advice. Always confirm important decisions with a qualified professional and official sources.