Hi, I am having some trouble in understanding “Capital Charge”. I do not quite understand what does it mean in itself and how does it impact residual income. This is the first time I am hearing this term.
I would appreciate if anyone can help me understand it.
Thanks!
The capital charge represents the opportunity cost of capital (represented in currency terms), with the idea that capital is not free and the providers must be compensated for their capital.
So if the residual income is positive, it means the after-tax earnings is enough to compensate the investors for their capital and there is still excess (which goes to shareholder’s wealth/firm value)