Question

Wintertime Inc. reported the following operating results for its three divisions: Parkas, Scarfs, and Gloves.

	Parkas	Scarfs	Gloves
Sales	$600,000	$500,000	$300,000
Net operating income	$150,000	$120,000	$60,000
Ave. divisional operating assets	$750,000	$600,000	$400,000

            Which division’s residual income would be considered as being the least favorable if Wintertime Inc.’s minimum required return on investments is 12% for all divisions.

Scarfs Division

Parkas Division

Gloves

The residual income is the same for all three divisions.

Answer 1

For Parkas division

Residual income = Net operating income - (Average divisional operating assets x Minimum required return on investments)

= 150,000 - (750,000 x 12%)

= 150,000 - 90,000

= $60,000

For Scarfs division

Residual income = Net operating income - (Average divisional operating assets x Minimum required return on investments)

= 120,000 - (600,000 x 12%)

= 120,000 - 72,000

= $48,000

For Gloves division

Residual income = Net operating income - (Average divisional operating assets x Minimum required return on investments)

= 60,000 - (400,000 x 12%)

= 60,000 - 48,000

= $12,000

Gloves division’s residual income would be considered as being the least favorable if Wintertime Inc.’s minimum required return on investments is 12% for all divisions.