In its 2005 annual report, TD Bank Financial Group (TD) reports economic profit of $1,062 million. Its calculation of economic profit is summarized as follows (millions of dollars):

Required

a. What is the relationship between TD’s calculation of economic profit and the calculation of firm value using clean surplus theory, illustrated in Example 6.2?

b. Does TD have unrecorded goodwill? Explain why or why not.

c. Amortization of intangibles of $354 million is added back to 2005 GAAP net income of $2,229 for purposes of calculating economic profit, on the grounds that net income before amortization of intangibles better measures bank performance. The goodwill and other intangibles arise because of TD’s acquisitions of Canada Trust in 2000 and Banknorth in 2005. Items of note of $278 are also added back. Items of note are defined in the annual report as items that management does not believe are indicative of underlying business performance. They include a charge for legal liability, costs of preferred share redemption, restructuring charge, loss on derivatives, and several related items.
As an investor in TD Bank shares, do you find economic income more or less useful than reported net income for predicting future bank performance? Explain. Focusing on economic income, do you find economic income before or after adding back amortization of intangibles and items of note to be most useful? Explain.

Transcribed Image Text:

7 Average common shareholders' equity for the year Add goodwill/intangibles amortized to date Average invested capital before goodwill amortization Net income per income statement Capital charge at 10.1% per annum, estimated using CAPM Economic profit after amortization of intangibles and items of note Amortization of intangibles ($354) and items of note ($278) Economic profit before amortization of intangibles and items of note abnormal carmy. $14,600 3,213 17,813 $ 2,229 1.799 430 632 $ 1,062