Kevin Thomas is the general manager of the Modular Homes Division, and his performance is measured using the residual income method. Thomas is reviewing the following forecasted information for his division for next year: (CMA adapted)
$$\begin{array} { l c }
\text { Category } & \text { Amount (thousands) } \
\text { Working capital } & \$ 1,800 \
\text { Reverue } & 30,000 \
\text { Plant and equipment } & 17,200
\end{array}$$
If the cost of capital is 15% and Thomas wants to achieve a residual income target of $2,000,000, what will costs have to be in order to achieve the target?
A) $9,000,000.
B) $10,800,000.
C) $25,150,000.
D) $25,690,000.

Question

Kevin Thomas is the general manager of the Modular Homes Division, and his performance is measured using the residual income method. Thomas is reviewing the following forecasted information for his division for next year: (CMA adapted)
$$\begin{array} { l c } 
\text { Category } & \text { Amount (thousands) } \
\text { Working capital } & \$ 1,800 \
\text { Reverue } & 30,000 \
\text { Plant and equipment } & 17,200
\end{array}$$
If the cost of capital is 15% and Thomas wants to achieve a residual income target of $2,000,000, what will costs have to be in order to achieve the target?
A) $9,000,000.
B) $10,800,000.
C) $25,150,000.
D) $25,690,000.

Quizplus · Accepted Answer

Residual income is calculated as operating income minus the product of the cost of capital and the total investment. The total investment is the sum of working capital and plant and equipment, which is $19,000,000. The required operating income to achieve a residual income of $2,000,000 is $4,850,000 ($2,000,000 + 15% of $19,000,000). Therefore, costs must be $25,150,000 ($30,000,000 revenue - $4,850,000 operating income).

Kevin Thomas Is the General Manager of the Modular Homes