Question

QUESTION 28

1. Which of the following would increase a division’s residual income?

   		an increase in the division’s expenses
   		an increase in the division’s assets
   		a decrease in the division’s required rate of return
   		a decrease in the division’s profit
   		a decrease in the division’s ROI

Answer 1

a decrease in the division’s required rate of return

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Residual income is the earning that is earned above the required rate of return. This means that a residual income is the excess income earned on the return on investment(that the managers targeted). Hence,if the required rate of return is decreased, obviously it would increase a division’s residual income.

For example if a divisions has- required rate of return- 10%, operating Assets = $100000, and Operating income = $20000

Then: required return on investment = 100000*10%= 10000, residual income= $20000-$10000 = $10000

accordingly if the required rate of return is 8%, then the residual income will be $12000 (20000-8000)

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Hope you understood,