Question

Discuss why NOPAT is used in calculating the value of a company instead of net income in the ROPI equity valuation model.

Answer 1

Firm Value under ROPI model = NOA + Present Value of Expected ROPI

Net Operating Profit After Tax (NOPAT) represents a company's income assuming it had zero debt (which means no interest expenses) on its books. This essentially aims to make different companies comparable by removing the effects of capital structure differences between them. Hence one can say NOPAT represents the operating activities of a firm and does not consider borrowing or investing activities. Net income which reflects both operating and borrowing/investinga activities. When net income is used, stockholders’ equity, rather than NOA, is the appropriate balance sheet amount. Hence the preference for NOPAT over Net Income in ROPI model.