Question

Assume the Hiking Shoes division of the All About Shoes Corporation had the following results last year​ (in thousands).​ Management's target rate of return is​ 20% and the weighted average cost of capital is​ 30%. Its effective tax rate is​ 40%.

Sales ​- $5,000,000
Operating income ​- 1,250,000
Total assets ​- 1,000,000
Current liabilities ​- 750,000
What is the​ division's Residual Income​ (RI)?

Answer 1

The division's residual income would be $1050,000.

Step-by-step explanation:

Residual income is a concept which is used by the management to see the internal company performance, where the management will see how much of return generated by the company is in excess of the minimum required rate of return.

Formula for taking out the residual income is =

Net operating income - ( Total assets x target rate of return )

Here net operating income - $1250,000

total assets - $1000,000

target rate of return - 20%

= $1250,000 - ( $1000,000 x 20% )

= $1250,000 - $200,000

= $1050,000.