Chartered Financial Analyst (CFA) Practice Exam Level 2

What is included in the calculation of NOPAT?

1. Sales - COGS - Interest Expense

2. EBIT - Taxes

3. (Sales - COGS - SGA - Depreciation) * (1 - t)

4. Gross Profit * (1 - t)

The correct answer is: (Sales - COGS - SGA - Depreciation) * (1 - t)

The calculation of Net Operating Profit After Taxes (NOPAT) focuses on evaluating a firm's operational efficiency by considering its profits after accounting for associated tax expenses but before financing costs. The correct approach involves starting with the operating income, specifically Earnings Before Interest and Taxes (EBIT), and reducing it by the effective tax rate. The method represented as "(Sales - COGS - SGA - Depreciation) * (1 - t)" accurately captures the necessary components: it begins with sales and deducts the cost of goods sold (COGS), selling, general, and administrative expenses (SGA), and depreciation, to arrive at EBIT. After obtaining EBIT, applying the effective tax rate, represented by "1 - t," ensures that taxes are accurately deducted from the operating profit, leading to the final NOPAT figure. This approach holistically reflects a firm's operational profitability, considering all relevant expenses directly related to operations, while excluding financing costs such as interest expenses. This exclusion is particularly crucial because NOPAT aims to assess performance independently of capital structure decisions. By focusing on the operational results, stakeholders can better evaluate the company's core business performance.