Question

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

	Small Appliances Division	Cleaning Products Division
Sales	$34,630,000	$31,340,000
Operating income	2,346,100	1,252,900
Operating assets, January 1	6,399,000	5,770,000
Operating assets, December 31	7,590,000	6,380,000

Forchen, Inc., requires an 9 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 10 percent? How would that affect the residual income of the two divisions?

Small Appliances Division residual income would be	lower.
Cleaning Products Division residual income would be	lower.

Answer 1

1. Small Appliances divison:

Average operating assets = (Beginning operating assets + Ending operating assets)/2 = ($6,399,000 + $7,590,000 )/2

= $6,994,500

Residual income = Operating income - Average operating assets *require rate of return

= 2,346,100 - 6,994,500 x 9% = $1716595

2. Cleaning Products division:

Average operating assets = (Beginning operating assets + Ending operating assets)/2 = ($5,770,000   + $6,380,000)/2

= $6,075,000

Residual income = Operating income - Average operating assets *require rate of return

= 1,252,900 - 6,075,000 x 9% = $706,150

3. Small Appliances divison:

Residual income = Operating income - Average operating assets *require rate of return

= 2,346,100 - 6,994,500 x 10% = $1646650

Cleaning Products division:

Residual income = Operating income - Average operating assets *require rate of return

= 1,252,900 - 6,075,000 x 10% = $645,400