Question

What challenges might a company face when using Economic Profit as a performance measure and how can they be addressed?

Using Economic Profit as a performance measure can present several challenges. Firstly, it may not be a comprehensive measure of a company's performance as it only considers the cost of capital and not other factors like market conditions or operational efficiency. Secondly, it can be difficult to calculate accurately, especially for large companies with complex financial structures. Lastly, it may not be a reliable indicator of future performance as it is based on past data. These challenges can be addressed by using Economic Profit in conjunction with other performance measures, ensuring accurate and transparent financial reporting, and regularly reviewing and updating the measure to reflect changes in the company's operations and market conditions.

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Economic Profit — the total profit after subtracting the cost of capital — is a good indicator to measure by how much a company has beaten the market. When the authors graphed the economic profit of 2,393 of the largest non-financial companies between 2010 to 2014 from highest to lowest, they found that these companies follow a power law with a long flat line in the middle and tails that rise and fall at exponential rates.

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