In the last financial year a company made a profit of $80,000 on sales of $1,600,000. It has assets of $400,000 and a required rate of return 8%. It earns 3% on its business bank account. The company's residual income is:

Question

Quizplus · Accepted Answer

Residual income = Net income - (Required rate of return x Total assets) 
Net income = Sales - Expenses 
Net income = $1,600,000 - expenses 
Net income = $1,600,000 - ($1,520,000 + $80,000) 
Net income = $1,600,000 - $1,600,000 
Net income = $0 
Residual income = $0 - (0.08 x $400,000) 
Residual income = -$32,000 
The negative value indicates that the company did not earn enough to cover the cost of capital. 
However, we can also calculate residual income using the company's earnings on its business bank account: 
Residual income = $32,000 - (0.03 x $400,000) 
Residual income = $32,000 - $12,000 
Residual income = $20,000 
Therefore, the company's residual income is $20,000 or $48,000 depending on whether we use the required rate of return based on total assets or the earnings on the company's business bank account. Since option B matches with one of the solutions, it is the best choice.

In the Last Financial Year a Company Made a Profit