Final answer:
Residual Income (RI) is calculated as Net Operating Income minus the product of Average Operating Assets and the Minimum required rate of return percentage. It measures corporate performance in income terms, showing how much is earned above the required return on assets.
Step-by-step explanation:
The formula provided in the question is used to calculate Residual Income (RI), which is a measure of corporate performance in terms of income.
Residual Income is calculated by taking the Net Operating Income(NOI) and subtracting the product of the Average Operating Assets multiplied by the Minimum required rate of return (expressed as a percentage). The Minimum required rate of return is often referred to as the 'cost of capital' or 'hurdle rate', which represents the minimum return that investors expect from an investment.
The Residual Income model is a valuable tool in performance measurement and management, as it helps companies to understand how much income is being generated above or below the required rate of return on its assets. It encourages managers to consider both the profits generated and the costs of financing the assets used to generate those profits. Positive Residual Income implies that the company is generating more than the minimum required return, which can be favorable for investment and performance evaluations.