The Rainy Division of Seattle Corporation reported the follo

The Rainy Division of Seattle Corporation reported the following results from the past year. Shareholders require a return of 13%. Management calculated a weighted minus average cost of capital (WACC) of 5%. Rainy\'s corporate tax rate is 35%. Sales…………………………………………………………………… $ 800,000 Operating income……………………………………………………… 160,000 Total assets……………………………………………………………... 1,100,000 Current liabilities………………………………………………………. 400,000 What is the division\'s Residual Income (RI)?

Solution

Before going to calculate RI we should know the ROI

ROI is the measurement ratio of efficiency of an organization that generates profit.

The following equation is helpful to calculate ROI

ROI=net income \'net operating assets *100

First calculate net income

Net income = operating income - interest -tax

$160,000-$8000-$56000= $96,000

Net operating assets = total assets - current liabilities  

=$1100,000-$400,000=$700,000

ROI =$96000/$700,000*100= 13.71 percent

Residual income = net income - (operating assets *required rate of return )

=$96000- $91000=$5000

Since the ROI is greater than the required rate so residual income is positive

Notes : interest = 160000*5/100=$8000

Tax = 160000*35/100=$56000

Thank you