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The link between residual income and value created for levered firms: A note

Authors
Journal
Management Accounting Research
1044-5005
Publisher
Elsevier
Publication Date
Volume
19
Issue
3
Identifiers
DOI: 10.1016/j.mar.2008.02.003
Keywords
  • Residual Income
  • Wacc
  • Value-Based Management
  • Performance Measurement

Abstract

Abstract In addition to other contributions to the literature, this note shows how value created can be measured if firms are financed not only by equity, but also by debt. We deal with this capital structure using the weighted average cost of capital (WACC) approach. We show that measuring value creation with residual incomes requires the use of a modified WACC for levered firms. Thus, we caution against applying the standard definition of WACC carelessly. This insight is important for all applications in which information about the performance of past periods is needed as for post-acquisition audits, capital budgeting or bonus banks.

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