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	$34,600,000	$31,350,000
Operating income	2,292,600	1,254,500
Operating assets, January 1	6,392,000	5,620,000
Operating assets, December 31	7,540,000	6,860,000

Forchen, Inc., requires an 6 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 7 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

	Small Appliances Division	Cleaning Products Division
Sales	$                           3,46,00,000	$                                3,13,50,000
Operating Income	$                              22,92,600	$                                   12,54,500
Average Operating Assets[(Operating assets as on jan 1+Operating assets as on dec 31)/2]	$                              69,66,000	$                                   62,40,000
Residual income =Net operating income -(Average Invested assets*6%)	$                              18,74,640	$                                     8,80,100
Residaul Income if ROR is 7%	$                              18,04,980	$                                     8,17,700
As it can be seen that the Residual Income of Small Appliances Division has been LOWER and Residual Income of Cleaning Products Division has also been LOWERED