Instantly calculate a company's residual income (economic profit) by factoring in the cost of equity. This tool is essential for company valuation, investment analysis, and understanding true profitability. See step-by-step instructions, examples, and FAQs below.
The residual income (RI), or economic profit, is the amount of income left after all the equity charges are subtracted from accounting net income. In other words, it is the accounting profit minus the equity charge.
Step 1: Take the company’s net income which is given in the income statement.
Step 2: Calculate equity charge: Equity charge = Equity capital × Cost of equity.
Step 3: Calculate residual income: Residual income = Net income – Equity charge.
Example: Company Alpha
Net income: $80,520,000
Equity capital: $800,000,000
Cost of equity: 12.3%
Equity charge: $800,000,000 × 12.3% = $98,400,000
Residual income: $80,520,000 - $98,400,000 = -$17,880,000
Related: Learn how to calculate the cost of equity using our CAPM Calculator.
The calculation of residual income is a significant measure that enables investors and financial analysts to get a clear idea of a company’s real economic profit instead of just relying on its accounting profit. The use of residual income to value a company is the most popular valuation model nowadays.
The residual income is the income left to a company after deducting all of the equity charges from the company’s net income.
The formula for calculating residual income is: Residual Income = Net Income – (Equity Capital × Cost of Equity)
Residual income is used for company valuation because it provides a more accurate measure of a company’s profitability by taking into account the cost of equity. It is widely used in valuation models to determine whether a company is truly creating value for its shareholders.
