For 2014, the New Products Division, of Testar Company, had operating income of

Question

For 2014, the New Products Division, of Testar Company, had operating income of $9,900,000 and operating assets of $46,700,000. The New Products Division has developed a potential new product that would require $10,400,000 in operating assets and would be expected to provide $3,300,000 in operating income each year. Testar has set a target return on investment (ROI) of 22% for each of its divisions. Assuming that the new product is put into production, calculate the residual income for the division. $598,000 $638,000 $438,000 $2,662,000

Explanation / Answer

Residual Income = Operating Income - (Minimum required return on assets * operating assets of the department)

Residual Income of New Product = $3300000 - (22% * 10400000) = $1012000

Residual Income for 2014 = $9900000 - (22% * 46700000) = -$374000

Net residual Income = $1012000 - $374000 = $638000

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