Residual income will be greater than zero when:
A) the firm's reported net income exactly equals the required level of earnings necessary to cover the cost of equity capital.
B) the firm's expected future income is greater than the required level of earnings necessary to cover the cost of equity capital.
C) the firm's expected future income exactly equals the required level of earnings necessary to cover the cost of equity capital.
D) the firm's expected future income is less than the required level of earnings necessary to cover the cost of equity capital.

Question

Quizplus · Accepted Answer

Residual income is the difference between the firm's net income and the required level of earnings necessary to cover the cost of equity capital. If the firm's expected future income is greater than the required level, the residual income will be positive. Therefore, choice B is the correct answer. A is incorrect because the residual income will only be greater than zero when the net income exceeds the required level, not just when they are equal. C and D are also incorrect because the residual income will only be positive when the future income is greater than the required level, not when they are equal or less than the required level.

Residual Income Will Be Greater Than Zero When