Question

Which of the following is the correct formula for calculating residual income?

A) Weighted average cost of capital - Net operating profit after tax
B) Operating income - Minimum acceptable operating income
C) Historical cost of assets - Accumulated depreciation
D) Operating income / Average assets

Answer 1

The correct formula for residual income is 'Operating income - Minimum acceptable operating income,' which shows the profit beyond the minimum expected by the company.

Step-by-step explanation:

The correct formula for calculating residual income is B) Operating income - Minimum acceptable operating income. Residual income is a measure of profitability used to determine the excess of operating income over the minimum acceptable income based on a company's cost of capital. In other words, it's the net operating income earned beyond the minimum rate of return. In this context, 'minimum acceptable operating income' generally refers to the income the company expects to generate at least, often calculated as the weighted average cost of capital multiplied by the company's operating assets.