Question 1

The following information is available for Kiss Company: 
$$\begin{array} { | l | r | } 
\hline \text { Sales } & \$ 100,000 \
\hline \text { Operating expenses } & \$ 94,000 \
\hline \text { Operating assets } & \$ 40,000 \
\hline \text { Stockholder's equity } & \$ 25,000 \
\hline \text { Cost of capital } & 10 \% \
\hline
\end{array}$$What is Kiss Company's residual income?
A) $2,000.
B) $2,500.
C) $3,500.
D) $4,000.

Accepted Answer

Residual income is calculated as operating income minus the product of operating assets and the cost of capital. Operating income is sales minus operating expenses, which is $6,000 ($100,000 - $94,000). The cost of capital charge is $4,000 ($40,000 * 10%). Therefore, residual income is $2,000 ($6,000 - $4,000).

Question 2

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)
$$\begin{array} { | l | r | } 
\hline \text { Category } & \begin{array} { r } 
\text { Amount } \
\text { (thousanos) }
\end{array} \
\hline \text { Working capital } & \$ 1,800 \
\hline \text { Revenue } & 30,000 \
\hline \text { Plant and equipment } & 17,200 \
\hline
\end{array}$$ 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.

Accepted Answer

Residual income is calculated as net income minus a cost of capital charge (the required rate of return multiplied by the average operating assets). To achieve a residual income target of $2,000,000, Thomas needs to earn a net income of $2,000,000 plus the cost of capital charge. Assuming the cost of capital is 15%, the cost of capital charge would be $15% × average operating assets. We are not given any information about the average operating assets, so we cannot calculate the cost of capital charge. However, we are given the forecasted net income, which is $3,150,000. Therefore, the total cost would be $3,150,000 + ($2,000,000 ÷ 15%) = $18,150,000. This means that B and D are incorrect. Since the question asks for costs, and the forecasted net income is $3,150,000, the total costs would be $25,150,000 (C). Therefore, C is the correct answer.

Question 3

Residual income is a performance evaluation that is used in conjunction with,or instead of,return on investment (ROI).In many cases,residual income is preferred to ROI because: (CIA adapted)
A) residual income is a measure over time,while ROI represents the results for one period.
B) residual income concentrates on maximizing absolute dollars of income rather than a percentage return,as with ROI.
C) the imputed interest rate used in calculating residual income is more easily derived than the target rate that is compared to the calculated ROI.
D) average investment is employed with residual income while year-end investment is employed with ROI.

Accepted Answer

The answer of Residual income is a performance evaluation that...

Question 4

In 2016,Evans Corporation had an operating profit of $750,000 and a residual income of $300,000.If Evans' cost of capital is 15%,what is the amount of the invested capital?
A) $5,000,000.
B) $3,000,000.
C) $2,000,000.
D) $1,250,000.

Accepted Answer

The answer of In 2016,Evans Corporation had an operating profit...

Question 5

Which of the following should not be used for the cost of capital to compute residual income?
A) Historical weighted average cost of capital.
B) Marginal after-tax cost of new equity capital.
C) Cost of debt and equity used to finance a project.
D) Return on investment (ROI).

Accepted Answer

Return on investment (ROI) is a measure of profitability and should not be used as a component of the cost of capital to compute residual income. The cost of capital should be based on the cost of debt and equity used to finance a project or business, which can include the historical weighted average cost of capital and the marginal after-tax cost of new equity capital.

Question 6

How will decreases in the following items affect residual income? $$\begin{array} { | l | l | l | } 
\hline & \text { Erpenses } & \text { Inventory } \
\hline \text { A. } & \text { Decrease } & \text { Decrease } \
\hline \text { B. } & \text { Decrease } & \text { Increase } \
\hline \text { C. } & \text { Increase } & \text { Decrease } \
\hline \text { D. } & \text { Increase } & \text { Increase } \
\hline
\end{array}$$
A) Option A
B) Option B
C) Option C
D) Option D

Accepted Answer

The answer of How will decreases in the following items...

Question 7

Managerial performance can be measured in many different ways including return on investment (ROI)and residual income.A good reason for using residual income instead of ROI is that:
A) residual income can be computed without regard to identifying an investment base.
B) appropriate goal congruence behavior is more likely to occur when using residual income.
C) residual income is well accepted in many organizations and often used in the financial press.
D) ROI does not take into consideration both the investment turnover ratio and return-on-sales percentage.

Accepted Answer

Using residual income instead of ROI is better because it promotes appropriate goal congruence behavior, meaning that the manager's actions are aligned with the goals of the organization. Additionally, residual income can be calculated without the need to identify an investment base, making it a more flexible measure. While residual income is not as widely accepted as ROI, it is still used in many organizations and can provide valuable insight into managerial performance. Finally, neither residual income nor ROI take into consideration the investment turnover ratio and return-on-sales percentage, so this is not a differentiating factor between the two measures.

Question 8

The following information has been gathered for the Door Division: C$$\begin{array} { | l | r | } 
\hline \text { Return on inw estment (Rol) } & 15.0 \% \
\hline \text { Sales } & \$ 120,000 \
\hline \text { Operating assets } & \$ 60,000 \
\hline \text { Cost of Capital } & 12.0 \% \
\hline \text { Profit margin } & 7.5 \% \
\hline
\end{array}$$ompute the Door Division's residual income. 
A) $1,800.
B) $2,700.
C) $3,600.
D) $5,400.

Accepted Answer

Residual income = (ROI - Cost of Capital) * Operating Assets= (15% - 12%) * $60,000= 3% * $60,000= $1,800

Question 9

The Pathways Company has an asset turnover of 3.0 times,using assets of $45,000.The company also has a return on investment (ROI)of 20%.If the residual income was $2,250,what was the company's cost of capital?
A) 6.0%.
B) 10.0%.
C) 15.0%.
D) 20.0%.

Accepted Answer

Residual income = net income - (required rate of return x assets)
$2,250 = (0.20 x $45,000) - (required rate of return x $45,000)
$2,250 = $9,000 - ($45,000 x required rate of return)
$45,000 x required rate of return = $9,000 - $2,250
$45,000 x required rate of return = $6,750
Required rate of return = $6,750 / $45,000
Required rate of return = 0.15 or 15%

Question 10

Use the following information to compute residual income: $$\begin{array} { | l | r | } 
\hline \text { Sales } & \$ 320,000 \
\hline \text { Operating inc ome } & \$ 60,000 \
\hline \text { Average current assets } & \$ 250,000 \
\hline \text { Cost of capital } & 12 \% \
\hline \text { Return on inw estment } & 15 \% \
\hline
\end{array}$$
A) $12,000.
B) $22,500.
C) $30,000.
D) $48,000.

Accepted Answer

Residual income is calculated as Operating Income minus the product of Average Current Assets and Cost of Capital. Here, it is $60,000 - ($250,000 * 12%) = $60,000 - $30,000 = $30,000.

Question 11

Which of the following will not result in an increase in the residual income,assuming other factors remain constant?
A) An increase in sales.
B) An increase in the minimum required rate of return.
C) A decrease in expenses.
D) A decrease in operating assets.

Accepted Answer

An increase in the minimum required rate of return will decrease the residual income, as the required return will be higher and the company's earnings will have to exceed that higher rate in order to generate positive residual income. The other options (A, C, and D) will either increase revenue or decrease expenses/assets, which will lead to an increase in the residual income.

Question 12

How will increases in the following items affect residual income? $$\begin{array} { | l | c | c | } 
\hline & \text { Sales } & \text { Equipment } \
\hline \text { A. } & \text { Decrease } & \text { Decrease } \
\hline \text { B. } & \text { Decrease } & \text { Increase } \
\hline \text { C. } & \text { Increase } & \text { Decrease } \
\hline \text { D. } & \text { Increase } & \text { Increase } \
\hline
\end{array}$$
A) Option A
B) Option B
C) Option C
D) Option D

Accepted Answer

An increase in sales typically increases residual income as it boosts net income. An increase in equipment usually decreases residual income due to higher capital charges.

Question 13

Which of the following statement(s)is/are true? (A)If a division's return on investment (ROI)exceeds its cost of capital,then its residual income is positive.(B)If a division's cost of capital equals its return on investment (ROI),then its residual income is zero.
A) Only (A)is true.
B) Only (B)is true.
C) Both (A)and (B)are true.
D) Neither (A)and (B)is true.

Accepted Answer

(A) If a division's ROI exceeds its cost of capital, then its residual income is positive because residual income is calculated as net income minus the cost of capital multiplied by the division's assets. If ROI is higher than the cost of capital, then the net income will be higher and the difference between the net income and the cost of capital multiplied by assets will be positive. 
(B) If a division's cost of capital equals its ROI, then its residual income is zero because in this case, net income will only be enough to cover the cost of capital and there will be no excess to generate positive residual income.

Question 14

Residual income is similar to the _________ notion of profit as being the amount left over after all costs,including the cost of the capital employed in the division,are subtracted.
A) accountant's
B) manager's
C) shareholder's
D) economist's

Accepted Answer

Residual income is a concept commonly used in economics, where it refers to the income generated by a firm or investment after accounting for the cost of the capital used to generate that income. This is similar to the economist's notion of profit, which takes into account opportunity costs and the cost of capital, and therefore differs from accounting profit. Managerial and shareholder perspectives may not necessarily account for the cost of capital in the same way, while economists would always consider this factor.

Question 15

Bella Vista Service Co.is a computer service center.For the month of May,Bella Vista Service Co.had the following operating statistics: (CMA adapted) 
$$\begin{array} { | l | r | } 
\hline \text { Sales } & \$ 450,000 \
\hline \text { Operating income } & 25,000 \
\hline \text { Net profit after taxes } & 8,000 \
\hline \text { Total assets } & 500,000 \
\hline \text { Stockholder's equity } & 200,000 \
\hline \text { Cost of capital } & 6 \% \
\hline
\end{array}$$Based on the above information,which one of the following statements is correct?
A) Bella Vista Service Co.has a return on investment of 4%.
B) Bella Vista Service Co.has a residual income of $(2,000).
C) Bella Vista Service Co.has a return on investment of 5.6%.
D) Bella Vista Service Co.has a residual income of $(22,000).

Accepted Answer

The answer of Bella Vista Service Co.is a computer service...

Question 16

All other things the same,which of the following would increase residual income?
A) Increase in average operating assets.
B) Decrease in average operating assets.
C) Increase in minimum required return.
D) Decrease in net operating income.

Accepted Answer

Residual income is calculated as net operating income minus a minimum required return multiplied by average operating assets. Therefore, decreasing average operating assets (option B) will increase residual income, as it will result in a smaller deduction for the minimum required return. Increasing average operating assets (option A), increasing the minimum required return (option C), and decreasing net operating income (option D) will all decrease residual income.

Question 17

Residual income is a better measure for performance evaluation of an investment center manager than return on investment because: (CMA adapted)
A) the problems associated with measuring the asset base are eliminated.
B) desirable investment decisions will not be neglected by high-return divisions.
C) only the gross book value of assets needs to be calculated.
D) the arguments about the implicit cost of interest are eliminateD.
Problems in measuring the asset base,gross versus net book values,and implicit cost of interest are present in both residual income and ROI.Residual income avoids the suboptimization problem with high return divisions.

Accepted Answer

Residual income is better because it encourages managers to make decisions that are beneficial for the company as a whole, even if those decisions might lower the division's return on investment.

Question 18

Division B had an ROI last year of 15%.The division's minimum required rate of return is 10%.If the division's average operating assets last year were $450,000,then the division's residual income for last year was:
A) $67,500.
B) $22,500.
C) $37,500.
D) $45,000.

Accepted Answer

ROI = Net operating income F1F1F1S1F1F1F10 Average operating assets
Net operating income = ROI F1F1F1S1F1F1F10 Average operating assets = 15% F1F1F1S1F1F1F10 $450,000 = $67,500
 11eaa48f_7b34_87a6_9e4a_3d1a3e8ba79e_TB2485_00

Question 19

Which of the following statement(s)is/are false? (A)Residual income can be used to compare divisions of different sizes.(B)Residual income can be used to compare divisions that are profit centers.
A) Only (A)is false.
B) Only (B)is false.
C) Both (A)and (B)are false.
D) Neither (A)and (B)is false.

Accepted Answer

The answer of Which of the following statement(s)is/are false? (A)Residual...

Question 20

Which one of the following items would most likely not be incorporated into the calculation of a division's investment base when using the residual income approach for performance measurement and evaluation?
A) Land being held by the division as a potential site for a new plant and parking lot.
B) Division inventories when division management exercises control over the inventory levels.
C) Division accounts payable when division management exercises control over the amount of short-term credit utilized.
D) Division accounts receivable when division management exercises control over credit policy and credit terms.

Accepted Answer

Land being held by the division as a potential site for a new plant and parking lot would not be incorporated into the calculation of a division's investment base when using the residual income approach since it is not generating any current income or expense for the division. The investment base should only include assets that are generating current income or expense for the division, such as inventory, accounts payable, and accounts receivable.

Quiz 14: Business Unit Performance Measurement

Residual income is a performance evaluation that is used in conjunction with,or instead of,return on investment (ROI) .In many cases,residual income is preferred to ROI because: (CIA adapted)

In 2016,Evans Corporation had an operating profit of $750,000 and a residual income of $300,000.If Evans' cost of capital is 15%,what is the amount of the invested capital?

Which of the following should not be used for the cost of capital to compute residual income?

Managerial performance can be measured in many different ways including return on investment (ROI) and residual income.A good reason for using residual income instead of ROI is that:

The Pathways Company has an asset turnover of 3.0 times,using assets of $45,000.The company also has a return on investment (ROI) of 20%.If the residual income was $2,250,what was the company's cost of capital?

Which of the following will not result in an increase in the residual income,assuming other factors remain constant?

Which of the following statement(s) is/are true? (A) If a division's return on investment (ROI) exceeds its cost of capital,then its residual income is positive.(B) If a division's cost of capital equals its return on investment (ROI) ,then its residual income is zero.

Residual income is similar to the _________ notion of profit as being the amount left over after all costs,including the cost of the capital employed in the division,are subtracted.

All other things the same,which of the following would increase residual income?

Residual income is a better measure for performance evaluation of an investment center manager than return on investment because: (CMA adapted)

Division B had an ROI last year of 15%.The division's minimum required rate of return is 10%.If the division's average operating assets last year were $450,000,then the division's residual income for last year was:

Which of the following statement(s) is/are false? (A) Residual income can be used to compare divisions of different sizes.(B) Residual income can be used to compare divisions that are profit centers.

Which one of the following items would most likely not be incorporated into the calculation of a division's investment base when using the residual income approach for performance measurement and evaluation?