Finance Formulas / June 15, 2018 / Rory Wise
Economic profit is a measurement of opportunity cost. Opportunity cost is the value of the trade-off when a decision is made. For example, an individual may consider returning to school to get a degree but in doing so, needs to quit his current job. The individual should consider not only the cost of tuition and books, but the income he forgoes by pursing a degree. This lost opportunity to make money, or opportunity cost, is the underlying purpose of calculating economic profit.
Coupon bonds are rare since most modern bonds are not issued in certificate or coupon form. Instead, bonds are formed electronically, though some holders still prefer to own paper certificates. For this reason, the coupon bond simply refers to the rate it projects rather than its physical nature in the form of certificates or coupons.
According to DuPont analysis, there are three major financial metrics drive return on equity (ROE): operating efficiency, asset use efficiency and financial leverage. Operating efficiency is represented by net profit margin or net income divided by average shareholders' equity. Asset use efficiency is measured by total asset turnover or the asset turnover ratio. Finally, financial leverage is analyzed through observation of changes in the equity multiplier.
Consider the following example to illustrate the concept. Assume hypothetical company BigBox has operating income or earnings before interest and taxes (EBIT) of $100 million in Year 1, with interest expense of $10 million, and has 100 million shares outstanding. (For the sake of clarity, let’s ignore the effect of taxes for the moment.)
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