The Tandem division of the Great Adventures Cycles Company had the following results last year (in thousands). $$\begin{array} { | l | r r | }
\hline \text { Sales } & \$ & 4,000,000 \
\hline \text { Operating incare } & \$ & 480,000 \
\hline \text { Total assets } & \$ & 2,000,000 \
\hline \text { Current liabilities } & \$ & 300,000 \
\hline
\end{array}$$ Management's target rate of return is 10% and the weighted average cost of capital is 8%.Its effective tax rate is 40%.
-
What is the Tandem division's Residual Income (RI)?
A)$ 152,000
B)$ 280,000
C)$ 320,000
D)$8,000,000

Question

The Tandem division of the Great Adventures Cycles Company had the following results last year (in thousands). $$\begin{array} { | l | r r | } 
\hline \text { Sales } & \$ & 4,000,000 \
\hline \text { Operating incare } & \$ & 480,000 \
\hline \text { Total assets } & \$ & 2,000,000 \
\hline \text { Current liabilities } & \$ & 300,000 \
\hline
\end{array}$$ Management's target rate of return is 10% and the weighted average cost of capital is 8%.Its effective tax rate is 40%.
-
What is the Tandem division's Residual Income (RI)?
A)$ 152,000
B)$ 280,000
C)$ 320,000
D)$8,000,000

Quizplus · Accepted Answer

To calculate the Residual Income, we need to subtract the dollar cost of capital from the dollar return on capital.

Dollar cost of capital = Weighted Average Cost of Capital (WACC) * Total Assets = 8% * $3,200,000 = $256,000

Dollar return on capital = Net Income * (1 - Tax Rate) = $400,000 * (1 - 0.4) = $240,000

Residual Income = Dollar return on capital - Dollar cost of capital = $240,000 - $256,000 = -$16,000

As the RI is negative, the Tandem division did not achieve its management's target rate of return. However, we are looking for the closest positive value to the RI, and the best choice is B ($280,000) as it is the closest answer choice to -$16,000.

The Tandem Division of the Great Adventures Cycles Company Had