Final answer:
The imputed charge in a residual income calculation is the product of the investment amount by the cost of capital rate. RI reflects a division's income exceeding its minimum expected ROI by considering the performance against the costs of capital. The RI formula is RI = Operating Income - (Investment × Cost of Capital).
Step-by-step explanation:
The imputed charge in a residual income (RI) calculation is determined by multiplying the level of investment in the business unit (or division) by the cost of capital rate for the company or division. Calculating residual income involves taking the actual operating income of a division and subtracting the imputed charge. The purpose of this calculation is to assess the performance of a division, taking into consideration not just the profit it makes but also the cost associated with the capital investment it requires.
Residual income is a financial metric used in performance measurement and valuation. It represents the income that exceeds the minimum required return on investment (ROI). The formula for residual income is:
RI = Operating Income - (Investment × Cost of Capital)
Where:
- Operating Income is the earnings before interest and taxes (EBIT).
- Investment is the total capital invested in the division.
- Cost of Capital represents the company's weighted average cost of capital (WACC) or the required rate of return for investors.