Hi,
I was doing Q 13 in capital budgeting reading EOC of the CFA curriculum on the Economic income and the answer at the back said that we will use Cashflows - Economic depreciation instead of cashflows + change in value. Please explain why? Also if anyone here can suggest how to figure out what formula or information to use when solving vignettes.
Economic depreciation is basically another way of saying “change in value” and is calculated as NPVt - NPVt+1. So those terms are actually identical.
Actually they are not the same (economic depreciation is negative of change in value).
Economic Income = Cashflows + (End Market Value - Beginning Market Value)
Economic Income = Cashflows - (Beginning Market Value - End Market Value) (Second term is economic depreciation this word makes sense where market value has decreased)
(note the “+” in first formula and “-” in the second formula).
there is no difference
cashflows + (Ending Market Value - Beginning Market Value)
= Cashflows - (beginning - End)
it is exactly the same … (just algebraic and sign manipulation)