Question

When Bubba asked Earl about residual income, he learned that residual income can be defined as:

A. That income left over after dividends are paid out.
B. Operating earnings minus return on investment.
C. Operating earnings minus a minimum acceptable return.
D. Operating earnings minus a minimum acceptable return, times invested capital.

Answer 1

Residual income is defined as operating earnings minus a minimum acceptable return, representing the earnings after covering the baseline return on capital that companies seek to surpass. It's also analogous to the income individuals retain for discretionary use after paying essential expenses.

Step-by-step explanation:

When Bubba asked Earl about residual income, he learned that it can be defined as operating earnings minus a minimum acceptable return. Essentially, residual income is the amount of earning generated after ensuring that capital has achieved a certain baseline return. It is a concept in corporate finance used to measure the performance of a company's management by assessing the wealth created relative to the capital invested.

Individuals can relate to the concept of residual income through their personal finances. After all essential obligations, such as bills and taxes, have been paid, the income that is left, which can be used for savings, investment, or discretionary spending, is akin to residual income for a household.