Crosby Inc. creates handmade silk neckties that it then sells on their website through a monthly subscription service. In an effort to increase membership, Crosby has promised their customers a one-day turnaround time on all orders. The largest bottleneck Crosby experiences is the cutting department due to the delicate nature of the material. To improve this process, Crosby has decided to buy a new cutting machine that would cost $12,400 with a useful life of 5 years. They estimated that this machine would generate $17,500 of sales and incur $8,788 of asset-specific expenses (excluding depreciation). If the company has a Required Rate of Return of 7.3%, then what is their Residual Income?

Question

Quizplus · Accepted Answer

This question requires familiarity with the formula for Residual Income: Operating Income - (Required Rate of Return × Investment). While expenses are given, calculate depreciation to include with the other expenses. $12,400/5 years = $2,480 per year. Total expenses will equal $8,788 + $2,480 = $11,268. Operating Income is not given, so solve for it using the following formula: Sales - Operating Expenses = $17,500 - $11,268 = $6,232. Now, solve for Residual Income. Residual Income = $6,232 - (0.073 × $12,400). Residual Income = $6,232.00 - $905.20. Residual Income = $5,326.80 (Choice B).