Teresa's Taco Ltd had the following results during the most recent year: Sales $500,000; Residual income $5,000; investment turnover 2.5; and a required rate of return of 15%. The operating (pretax) profit was
A) $30,500
B) $192,500
C) $35,000
D) $16,250

Question

Quizplus · Accepted Answer

Operating profit can be calculated using the Residual Income formula:

Residual Income = Operating Profit - (Required Rate of Return x Total Assets)
$5,000 = Operating Profit - (0.15 x Total Assets)

Investment turnover is calculated by dividing Sales by Total Assets:

Investment Turnover = Sales / Total Assets
2.5 = $500,000 / Total Assets
Total Assets = $200,000

Substituting Total Assets in the Residual Income formula, we get:

$5,000 = Operating Profit - (0.15 x $200,000)
Operating Profit = $5,000 + $30,000
Operating Profit = $35,000

Therefore, the operating (pretax) profit was $35,000. Option C is the best choice.

Teresa's Taco Ltd Had the Following Results During the Most