Which metric captures earning above the cost of capital, signaling economic profit?

• A. Net Income
• B. Revenue Growth
• C. Economic Profit
• D. Gross Margin

Answer: (C)

The idea being tested is whether a metric shows earnings after the capital used has been charged for. Economic profit does exactly that: it subtracts the cost of capital from the earnings the business generates. In practice, economic profit (often called economic value added) equals NOPAT minus the capital charge (the cost of capital times invested capital). If this number is positive, the firm is earning more than what investors could have earned elsewhere, creating value; if negative, value is being destroyed.

This differs from net income, which is accounting profit and doesn’t account for the opportunity cost of equity capital. Revenue growth focuses on top-line expansion and doesn’t reflect profitability after capital costs. Gross margin looks at profitability after direct production costs but ignores the capital employed. Therefore, the metric that best signals earning above the cost of capital is economic profit.