Comment, question or quotation of the day

14-10-2021 : Quote of the day


Life is too short for accounting. - Andréas Barckow, IASB chairman

13-10-2021 : Question from a practitioner


"Can we say that if ROCE is higher than WACC, then the return on equity is higher than the cost of equity?"


 

Yes, there is no doubt about that and it can be seen in the following way:

 

If the ROCE is higher than the WACC, then the entreprise value is higher than the carrying amount of the operating assets.

 

Since the value of the net debt has no reason to be greater than its carrying amount simply because the ROCE is higher than the WACC (since the debt does not participate in the creation of value beyond  the interest rate paid), and since the value of equity is equal to the entreprise value less the value of the net debt, the surplus between the entreprise value and the carrying amount of operating assets, benefits only to shareholders and not to debt holders.

 

Therefore, the value of equity is greater than the book value of equity as it is equal to the book value + this surplus.

 

And if the value of equity is greater than its book value, it is that the return on equity is higher than the cost of equity.

 

For more see, chapter 26 of the Vernimmen.

 

Have a nice day.


 



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The Vernimmen.com Letter

Number 138 of July 2021

News : New listing methods

Statistics : Dividends and share buybacks on both sides of the Atlantic

Research : The internal capital markets: an alternative to bank credit in times of crisis

Q&A : A few questions and short answers

COMMENTS : Comments posted on Facebook