In the MD&A section of its 2001 Annual Report, Northern National Bank reports “economic profit.” This consists of cash operating earnings less a capital charge of 12.5%, which is the bank’s cost of common equity capital. The amounts for the last two years are as follows:

                                                                                                             2001         2000

Net income after preferred share dividends ($ millions)       $2,139       $1,621

Add amortization of goodwill, other intangibles,

and one-time items                                                                            87             168

Cash operating earnings                                                              2,226          1,789

Capital charge                                                                              (1,460)        (1,386)

Economic income                                                                          $766             $403

Required

a. Relate the concept of economic income here to the clean surplus valuation procedure. Does Northern National Bank have unrecorded goodwill? (No calculations needed.)

b. Northern National Bank also breaks down results for its major business segments. For example, the personal and commercial financial services segment contributed $468 million of the $766 total economic income for 2001. If you were the manager of a Northern National Bank segment, would your propensity to incur large capital expenditures be affected by your knowledge that economic income was a factor in evaluating your performance? Explain why or why not.

c. What new information, if any, is conveyed to the market by Northern National Bank’s disclosure of cash operating earnings and economic income? Why does Northern National Bank make these disclosures?

Answer rating: 100% (QA)

a ANSWER Economic income is related to the clean surplus valuation procedure in that it represents t... View the full answer