Calculating Residual Income Forchen, Inc., provided the following information fo

Question

Calculating Residual Income

Forchen, Inc., provided the following information for two of its divisions for last year:

Forchen, Inc., requires an 8 percent minimum rate of return.

Required:

1. Calculate residual income for the Small Appliances Division.

$  

2. Calculate residual income for the Cleaning Products Division.

$  

3. What if the minimum required rate of return was 9 percent? How would that affect the residual income of the two divisions?

Small Appliances Division residual income would be - Select your answer -higher.lower.unaffected.Item 3 Cleaning Products Division residual income would be - Select your answer -higher.lower.unaffected.Item 4

Explanation / Answer

Formulas:

Residual Income = Operating Income - Average Operating Assets*Rate of Return(%)

Average Operating Assets = (Opening+Closing Operating Assets)/2

3.If Minimum rate of return changes to 9% then Residual income will be lower than the Residual income computed @8% minimum rate of Return

Formulas:

Residual Income = Operating Income - Average Operating Assets*Rate of Return(%)

Average Operating Assets = (Opening+Closing Operating Assets)/2

Operating Assets as on Small Appliances($) Cleaning Products($) 01- Jan 6394000 5600000 31- Dec 7474000 6000000 Average Operating Assets 6934000 5800000 Operating Income 2773600 1252800 Residual Income(@8% Rate) 2218880 788800 Residual Income(@9% Rate) 2149540 730800 Lower Residual Income 69340 58000

3.If Minimum rate of return changes to 9% then Residual income will be lower than the Residual income computed @8% minimum rate of Return

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