Recycle Management has a subsidiary that recycles waste with two subsidiaries—pa
ID: 2456552 • Letter: R
Question
Recycle Management has a subsidiary that recycles waste with two subsidiaries—paper and plastic Information related to the two subsidiaries follows:
Paper
Plastic
Total assets
$11,000,000
$70,000,000
Current liabilities (65% interest-bearing)
3,000,000
12,000,000
Net income
1,700,000
6,000,000
Interest expense
1,250,000
600,000
Tax rate
30%
32%
The required rate of return is 14%. The cost of capital is 8%. How much is the residual income of Plastic?
Paper
Plastic
Total assets
$11,000,000
$70,000,000
Current liabilities (65% interest-bearing)
3,000,000
12,000,000
Net income
1,700,000
6,000,000
Interest expense
1,250,000
600,000
Tax rate
30%
32%
Explanation / Answer
Residual Income (RI)
In the context of management accounting, residual income is a metric used to measure performance of a department. It measures the return earned by the department which is in excess of the minimum required return.
In the above formula,
A = Net operating income;
B = Capital employed; and
C = Required Rate of return on capital employed
Net operating income = Net income + Tax + Interest expense
= 6,000,000 + 2,823,529 (6,000,000*32/68) + 600,000
= $ 9,423,529.
Capital employed = Total asset - Current liabilities
= 70,000,000 - 12,000,000
= $ 58,000,000
Residual Income of Plastic = 9,423,529 - ( 58,000,000 * 14% )
= 9,423,529 - 8,120,000
= $ 1,303,529 .
Residual Income (RI) = A (B × C)Related Questions
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