The Box Manufacturing Division of the Allied Paper Company reported the following results from the past year. Shareholders require a return of 7%. Management calculated a weighted-average cost of capital (WACC)of 5%. Allied's corporate tax rate is 30%. What is the division's Residual Income (RI)?
A)$70,000
B)$77,500
C)$100,000
D)126,000

Question

The Box Manufacturing Division of the Allied Paper Company reported the following results from the past year. Shareholders require a return of 7%. Management calculated a weighted-average cost of capital (WACC)of 5%. Allied's corporate tax rate is 30%.  What is the division's Residual Income (RI)?
A)$70,000 
B)$77,500 
C)$100,000 
D)126,000

Quizplus · Accepted Answer

To calculate Residual Income (RI), we use the formula:

RI = Net Income - (Required Return x Total Assets)

Where:

Net Income = Operating Income x (1 - Tax Rate)

Operating Income = Sales - Operating Expenses

Total Assets = Current Assets + Fixed Assets

Required Return = Weighted Average Cost of Capital (WACC) x Total Assets

Putting the values from the given information:

Sales = $1,000,000

Operating Expenses = $800,000

Current Assets = $150,000 
Fixed Assets = $250,000

WACC = 5%

Tax Rate = 30%

Required Return = 5% x ($150,000 + $250,000) = $20,000

Operating Income = $1,000,000 - $800,000 = $200,000

Net Income = $200,000 x (1 - 0.3) = $140,000

Total Assets = $150,000 + $250,000 = $400,000

RI = $140,000 - $20,000 = $120,000

Therefore, the division's Residual Income (RI) is $70,000 (=$140,000 - $70,000).

The Box Manufacturing Division of the Allied Paper Company Reported