James Webb is the general manager of the Industrial Product Division, and his performance is measured using the residual income (RI) method. Webb is reviewing the followed forecasted information for his division for the coming year: If the imputed interest charge is 15% and Webb wants to achieve an RI target of $2 million, what will costs have to be in order to achieve the target?

Question

James Webb is the general manager of the Industrial Product Division, and his performance is measured using the residual income (RI) method. Webb is reviewing the followed forecasted information for his division for the coming year:  If the imputed interest charge is 15% and Webb wants to achieve an RI target of $2 million, what will costs have to be in order to achieve the target?

Quizplus · Accepted Answer

The formula for residual income is as follows:

Residual Income = Operating Income - (Imputed Interest Rate x Total Assets)

To achieve a target residual income of $2 million, we need to set up the equation as follows:

$2,000,000 = Operating Income - (0.15 x Total Assets)

Solving for Operating Income, we get:

Operating Income = $2,000,000 + (0.15 x Total Assets)

From the forecasted information given, we know that Operating Income for the coming year is expected to be $3,620,000. Substituting this value into the equation, we get:

$3,620,000 = $2,000,000 + (0.15 x Total Assets)

Solving for Total Assets, we get:

Total Assets = ($3,620,000 - $2,000,000) / 0.15

Total Assets = $10,800,000

Therefore, costs will have to be equal to Total Assets in order to achieve the target RI.

Costs = Total Assets = $10,800,000

The correct answer is D ($25,150,000)

James Webb Is the General Manager of the Industrial Product