Petra Company has the following information available for one of its divisions:
$\begin{array}{lr}
\text { Average operating assets } & \$ 2,500,000 \
\text { Sales } & \$ 4,000,000 \
\text { Return on investment (ROI) } & 40 \%
\end{array}$
If Petra's cost of capital is 25%,what is the division's residual income?
A)$1,500,000
B)$1,000,000
C)$375,000
D)$975,000
E)None of the answer choices is correct.

Question

Quizplus · Accepted Answer

Residual income is calculated as the operating income minus the product of the average operating assets and the cost of capital. The operating income can be derived from ROI: $ \text{Operating Income} = \text{ROI} \times \text{Average Operating Assets} = 0.40 \times \$2,500,000 = \$1,000,000 $. The cost of capital charge is $ 0.25 \times \$2,500,000 = \$625,000 $. Therefore, the residual income is $ \$1,000,000 - \$625,000 = \$375,000 $.

Petra Company Has the Following Information Available for One of Its