Question

The New Products Division of Testar Company had operating income of $8,000,000 and operating assets of $44,800,000 during the current year. The New Products Division has developed a potential new product that would require $8,500,000 in operating assets and would be expected to provide 1,400,000 in operating income each year. Testar has set a target return on investment (ROI) of 16% for each of its divisions. Assuming that the new prod is put into prod, calculate the residual income for the division.

Answer 1

Residual income for the division = $872,000

Step-by-step explanation:

Given:

Operating income = $8,000,000

Operating assets = $44,800,000

Additional operating assets = $8,500,000

Additional operating income = $1,400,000

Target return on investment (ROI) = 16%

Computation:

Total operating assets = $44,800,000 + $8,500,000

Total operating assets = $53,300,000

Total operating income = $8,000,000 + $1,400,000

Total operating income = $9,400,000

Required Income = Total operating assets × Return on investment (ROI)

Required Income = $53,300,000 × 16%

Required Income = $8,528,000

Residual income for the division = Total operating income - Required Income

Residual income for the division = $9,400,000 - $8,528,000

Residual income for the division = $872,000

Answer 2

$872,000

Step-by-step explanation:

The computation of the residual income is shown below:

But before that first we have to determine the operating assets which is shown below:

= Total operating assets × target rate of return

= ($44,800,000 + $8,500,000) × 16%

= $8,528,000

And, the operating income is

= $8,000,000 + $1,400,000

= $9,400,000

So, the residual income is

= Operating income - operating assets

= $9,400,000 - $8,528,000

= $872,000