James Webb is the general manager of the Industrial Product Division,and his performance is measured using the residual income method.Webb is reviewing the following forecasted information for his division for next year: (CMA adapted) If the cost of capital is 15% and Webb wants to achieve a residual income target of $2,000,000,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 method.Webb is reviewing the following forecasted information for his division for next year: (CMA adapted)  If the cost of capital is 15% and Webb wants to achieve a residual income target of $2,000,000,what will costs have to be in order to achieve the target?

Quizplus · Accepted Answer

Residual income = Net Income - (Cost of Capital x Total Investment)
Knowing that Webb wants to achieve a residual income target of $2,000,000, we can set up the equation:
$2,000,000 = Net Income - (0.15 x Total Investment)
Solving for Total Investment:
Total Investment = (Net Income - $2,000,000) / 0.15
Substituting the values from the table:
Total Investment = ($25,000,000 - $2,000,000) / 0.15 = $157,000,000
Finally, we can calculate the costs required to achieve the target by subtracting the forecasted net income from the total investment:
Costs = Total Investment - Net Income = $157,000,000 - $25,000,000 = $132,000,000.
Therefore, the answer is (C) $25,150,000.

James Webb Is the General Manager of the Industrial Product