Wealth Added
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Wealth Added is the excess returns above a risk-adjusted cost of capital. Also known as economic profit, it factors in the capital employed to produce the returns and the risks associated with each investment.
The capital employed is the opening market value of our portfolio at the start of the year, adjusted for any net capital movements.
In computing Wealth Added to our shareholder, the changes in our recurring operating costs taken into perpetuity are also accounted for.
Calculating Wealth Added
The total return to the shareholder is the change in the market value of investments, or the change in book value for unlisted assets, plus dividends paid to him, adjusted for any net new capital invested.
The capital charge is the risk-adjusted hurdle that the shareholder expects, based on the opening market value of his portfolio at the start of the year.
Wealth Added is the total return to the shareholder less the capital charge.
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Download this chartIllustrative Example:
Consider a listed investment with the following parameters:
| Opening market value | : $1,000 |
|---|---|
| Closing market value | : $1,200 |
| Dividends received | : $40 |
| Year-end equity invested | : $130 |
| Risk-adjusted hurdle rate | : 10% |
Thus,
| Total return | = ($1,200 – $1,000) + $40 – $130 | = $110 |
|---|---|---|
| Capital charge | = 10% hurdle rate x $1,000 | = $100 |
| Wealth Added | = total return – capital charge | = $10 |
In the following year, the capital charge is calculated on the new opening market value of $1,200.
Assuming no net capital movements or dividends, the portfolio value must increase by a hurdle of at least $120 (i.e. 10% of $1,200) to achieve positive Wealth Added, compared to a capital charge of $100 the year before. Thus as the portfolio value grows, the hurdle to achieve positive Wealth Added is progressively higher.
- 1 Prior to 2003, Wealth Added was calculated on an aggregate top-down basis. From 2003 onwards, Wealth Added is calculated on a bottom-up basis, investment by investment.