Residual Income Calculator
From net profit, equity and the required return, compute the residual income after the cost of equity capital.
Input Data
Results
At a glance:Residual income is profit after charging for equity capital. Residual income = net income − equity × required return%. If positive, the business earns more than the cost of equity and creates value; if negative, it destroys value.
Formula
Residual income = net income − equity × required return%.
How to Use
- Enter the net income.
- Enter the equity and the required return rate.
- Read the residual income.
FAQ
How is residual income different from net profit?
Net profit is the accounting bottom line, but it ignores the cost of shareholders' capital. Shareholders' money carries an opportunity cost — a minimum required return for the risk taken — which net profit does not deduct. Residual income subtracts this equity charge (equity × required return) from net profit, measuring whether the firm truly creates value beyond shareholders' expectations. A profitable company can still have negative residual income.
Does negative residual income mean the company is loss-making?
Not necessarily. Negative residual income means the firm earns accounting profit but below shareholders' minimum required return — it is 'consuming value' rather than creating it. That differs from a net loss (negative net profit). For example, net profit of HK$300,000 with an equity charge of HK$500,000 gives residual income of −HK$200,000: still profitable, just 'not profitable enough'.
How should I set the required return rate?
Use the cost of equity — the minimum return shareholders demand for the risk, often estimated with CAPM: risk-free rate + beta × market risk premium. Riskier firms warrant a higher rate, and this subjective input strongly affects the result — the higher it is, the lower the residual income. For Hong Kong, the risk-free rate can reference Exchange Fund Notes or HKD government bond yields. Run a sensitivity analysis over a range (e.g. 8%–15%).
What is the difference between residual income and EVA?
Both are 'profit minus capital cost', but from different angles. Residual income is shareholder-focused: net income minus equity × required return (equity cost only). EVA is capital-focused: NOPAT minus invested capital × WACC, covering both shareholders and creditors. Residual income is simpler and common in equity valuation (the residual income model); EVA is used more for firm-wide value management and performance.
How does the required return relate to ROE for Hong Kong investors?
Residual income is positive exactly when ROE exceeds the required return. Estimate the required return with CAPM using HKD risk-free yields and market data; the rate is subjective and directly moves the conclusion. Use a range and check robustness rather than a single number. Our CAPM and cost-of-equity calculators can help.
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References
Content review: Calculatorism Finance Team. Results are for reference only; please refer to the relevant authorities for the official figures.