Question

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

	Small Appliances Division	Cleaning Products Division
Sales	$34,600,000	$31,350,000
Operating income	2,762,000	1,252,200
Operating assets, January 1	6,396,000	5,700,000
Operating assets, December 31	7,530,000	6,250,000

Forchen, Inc., requires an 8 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 9 percent? How would that affect the residual income of the two divisions?

Small Appliances Division residual income would be: lower, higher, or unaffected
Cleaning Products Division residual income would be: lower, higher or unaffected

Answer 1

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		8%			9%
		Small	Cleaning		Small	Cleaning
Operaing Assets, Beginning	x	$      6,396,000	$      5,700,000		$   6,396,000	$5,700,000
Operaing Assets, Ending	y	$      7,530,000	$      6,250,000		$   7,530,000	$6,250,000
Average Operating Assets	a=(x+y)/2	$      6,963,000	$      5,975,000		$   6,963,000	$5,975,000
Required Rate of Return	b	8%	8%		9%	9%
Required Operating Income	a*b	$      557,040.0	$      478,000.0		$   626,670.0	$537,750.0
Actual Operating Income	c	$      2,762,000	$      1,252,200		$   2,762,000	$1,252,200
Required Operating Income	a*b=d	$      557,040.0	$      478,000.0		$   626,670.0	$537,750.0
Residual Income	c-d	$ 2,204,960.0	$     774,200.0		$2,135,330.0	$714,450.0
					Lower	Lower
					$      69,630.0	$ 59,750.0