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 $34,630,000      $31,350,000     
Operating income 2,653,000      1,253,000     
Operating assets, January 1 6,393,000      5,730,000     
Operating assets, December 31 7,530,000      6,040,000     

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
Cleaning Products Division residual income would be

Answer 1

1. Calculate residual income for the Small Appliances Division.

Small application division
Average operating assets = (6,393,000+7,530,000 )/2 (A)	6961500
Multiplied By: Required rate of return (b)	6%
Required Operating income (c=A*B)	417690
Actual Operating income	2653000
Less: Required Operating income	417690
Residual income	2235310

Residual income for the Small Appliances Division =$2,235,310

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2. Calculate residual income for the Cleaning Products Division.

Cleaning Product division
Average operating assets = (5,730,000+6,040,000 )/2 (A)	5885000
Multiplied By: Required rate of return (b)	6%
Required Operating income (c=A*B)	353100
Actual Operating income	1,253,000
Less: Required Operating income	353,100
Residual income	899900

Residual income for the Cleaning Product Division =$2,235,310

_________________________________________________________

3. What if the minimum required rate of return was 7 percent? How would that affect the residual income of the two divisions?

Small application division
Average operating assets = (6,393,000+7,530,000 )/2 (A)	6961500
Multiplied By: Required rate of return (b)	7%
Required Operating income (c=A*B)	487305
Actual Operating income	2,653,000
Less: Required Operating income	487305
Residual income	2165695
Cleaning Product division
Average operating assets = (5,730,000+6,040,000 )/2 (A)	5885000
Multiplied By: Required rate of return (b)	7%
Required Operating income (c=A*B)	411950
Actual Operating income	1,253,000
Less: Required Operating income	411,950
Residual income	841050

Small Appliances Division residual income would be Lower
Cleaning Products Division residual income would be Lower