A corporation has a required rate of return of 13% for all subsidiaries.The Calgary subsidiary earned residual income of $200,000 in year 1, and $300,000 in year 2 on an investment base of $4,500,000.What rate of return did the Calgary subsidiary earn in years 1 and 2 respectively?
A)17.4% and 19.7%
B)4.4% and 6.7%
C)13.0% and 13.0%
D)7.9% and 10.9%
E)10.00% and 13.00%

Question

Quizplus · Accepted Answer

Residual income = Net income - (required rate of return x investment base)

For year 1:

200,000 = Net income - (0.13 x 4,500,000)

Net income = 670,000

Return on investment = Net income / investment base = 670,000 / 4,500,000 = 0.1489 or 14.89%

For year 2:

300,000 = Net income - (0.13 x 4,500,000)

Net income = 975,000

Return on investment = Net income / investment base = 975,000 / 4,500,000 = 0.2167 or 21.67%

The closest answer choice is A: 17.4% and 19.7%, which are reasonable estimates based on the calculations.

A Corporation Has a Required Rate of Return of 13