192  Frameworks for Valuation
little insight into the company’s competitive position and economic perfor-
mance. Declining free cash flow can signal either poor performance or invest-
ment for the future. The economic-profit model highlights how and when the 
company creates value, yet properly implemented, it leads to a valuation that 
is identical to that of enterprise DCF.
Economic profit measures the value created by the company in a single 
period and is defined as follows:
Economic Profit
Invested Capital
ROIC
WACC
=
×
−
(
)
Since ROIC equals NOPAT divided by invested capital, we can rewrite the 
equation as follows:
Economic Profit
NOPAT
Invested Capital
WACC
=
−
×
(
)
Exhibit 10.13 presents economic-profit calculations for GlobalCo using 
both methods. Not surprisingly, with an ROIC more than double its cost of 
capital, GlobalCo generates significant economic profits.
To demonstrate how economic profit can be used to value a company—
and to demonstrate its equivalence to enterprise DCF—consider a stream of 
growing cash flows valued using the growing-perpetuity formula:
Value
FCF
WACC
0
1
=
−g
In Chapter 3, we transformed this cash flow perpetuity into the key value 
driver model. The key value driver model is superior to the simple cash 
flow perpetuity model, because it explicitly models the relationship between 
growth and required investment. Using a few additional algebraic steps (de-
tailed in Appendix A) and the assumption that the company’s ROIC on new 
projects equals the ROIC on existing capital, it is possible to transform the 
cash flow perpetuity into a key value driver model based on economic profits:
Value
Invested Capital
Invested Capital
ROIC
WACC
WACC
0
0
0
1
=
+
×
−
(
)
−g
Finally, we substitute the definition of economic profit:
Value
Invested Capital
Economic Profit
WACC
0
0
1
=
+
−g
As can be seen in the economic-profit-based key value driver model, the 
operating value of a company equals its book value of invested capital plus 
the present value of all future value created. In this case, the future economic 

Economic Profit-Based Valuation Models  193
profits are valued using a growing perpetuity, because the company’s eco-
nomic profits are increasing at a constant rate over time. The formula also 
demonstrates that when economic profit is expected to be zero, the value of 
operations will equal invested capital. If a company’s value of operations ex-
ceeds its invested capital, be sure to identify the sources of competitive ad-
vantage that allows the company to maintain superior financial performance.
More generally, economic profit can be valued as follows:
Value
Invested Capital
Economic Profit
WACC
0
0
1
1
=
+
+
=
∞
∑
t
t
t
(
)
Since the economic-profit valuation was derived directly from the free cash 
flow model (see Appendix A for a general proof of equivalence), any valuation 
based on discounted economic profits will be identical to enterprise DCF. To 
assure equivalence, however, it is necessary to do the following:
• Use beginning-of-year invested capital (i.e., last year’s value) instead of 
average or current-year invested capital, which is common to competi-
tive benchmarking.
• Define invested capital for both economic profit and ROIC using the 
same value. For example, ROIC can be measured either with or without 
EXHIBIT 10.13  GlobalCo: Economic-Profit Summary
$ million, except where noted
 
Year 1
Year 2
Year 3
Method 1
Return on invested capital,1 %
24.2
22.3
20.3
Weighted average cost of capital, %
(7.8)
(7.8)
(7.8)
Economic spread, %
16.4
14.5
12.5
× Invested capital1
248.0
310.0
356.5
= Economic profit
40.7
44.8
44.6
Method 2
Invested capital1
248
310
357
× Weighted average cost of capital, %
7.8
7.8
7.8
= Capital charge
19.3
24.2
27.8
NOPAT
60.0
69.0
72.5
Capital charge
(19.3)
(24.2)
(27.8)
Economic profit
40.7
44.8
44.6
Including goodwill
Economic profit including goodwill
32.9
37.0
36.8
1 Invested capital measured at the beginning of the year, excluding goodwill and acquired intangibles.