Question

Calculating Residual Income

Forchen, Inc., provided the following information for two of its divisions for last year:

	Small Appliances Division	Cleaning Products Division
Sales	$34,610,000	$31,300,000
Operating income	2,619,700	1,252,300
Operating assets, January 1	6,395,000	5,740,000
Operating assets, December 31	7,520,000	7,000,000

Forchen, Inc., requires an 7 percent minimum rate of return.

Required:

1. Calculate residual income for the Small Appliances Division.

$

2. Calculate residual income for the Cleaning Products Division.

$

3. What if the minimum required rate of return was 8 percent? How would that affect the residual income of the two divisions?

Small Appliances Division residual income would be	higher./ lower. / unaffected
Cleaning Products Division residual income would be  higher./ lower. / unaffected

Answer 1

Residual income = Operating income - (Average operating assets * Minimum rate of return)

1.

Residual income for the Small Appliances Division = $2,619,700 - [($6,395,000+$7,520,000)/2*7%]

= $2,132,675

2.

Resiual income for the Cleaning Products Division = $1,252,300 - [($5,740,000+$7,000,000)/2*7%]

= $806,400

3.

Residual income for the Small Appliances Division = $2,619,700 - [($6,395,000+$7,520,000)/2*8%]

= $2,063,100

Lower

Resiual income for the Cleaning Products Division = $1,252,300 - [($5,740,000+$7,000,000)/2*8%]

= $742,700

Lower