Residual income

CFA Level I Glossary

Residual income is net income minus an equity charge equal to required return times beginning book equity. It measures profit after charging for the opportunity cost of equity capital. Residual income models are useful when free cash flows are negative early but book value and earnings are cleaner to project. Confusing residual income with EBITDA or with economic profit based on WACC and invested capital muddies the capital charge.

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