Final answer:
Residual income is the net operating income minus the expected return on average operating assets. For a net operating income of $87,000, operating assets of $500,000, and a required return rate of 15%, the residual income is calculated to be $12,000.
Step-by-step explanation:
Residual income is a key financial metric that assesses the performance of an investment or business unit by measuring the income that exceeds the minimum required rate of return on invested capital. In the given scenario, the calculation of residual income involves deducting the product of average operating assets and the minimum required rate of return from the net operating income.
Firstly, the net operating income is established at $87,000. The average operating assets, representing the capital invested in the business, amount to $500,000. To determine the minimum required rate of return, the average operating assets are multiplied by the specified rate, which is 15%. This yields a minimum required return of $75,000 (calculated as $500,000 * 15%).
The residual income is then computed by subtracting the minimum required return from the net operating income. Therefore, $87,000 - $75,000 equals a residual income of $12,000.
This positive residual income of $12,000 indicates that the business or investment has generated earnings exceeding the minimum required return. It is a favorable outcome as it signifies that the venture is not only meeting the specified rate of return but is surpassing it, contributing additional income to the stakeholders. Residual income is a valuable metric for evaluating the economic value added by an investment or business unit beyond the cost of capital, providing insights into its profitability and overall financial performance.