Answer (B) is correct . Residual income is the excess of the actual ROI in dollars over a targeted amount equal to an imputed interest charge on invested capital. The rate used is ordinarily the weighted-average cost of capital. Some entities measure managerial performance in terms of the amount of residual income rather than the percentage ROI. Assuming the investment base is defined as total assets available, Charlie’s targeted amount is $30,000 ($500,000 total assets × 6% cost of capital). Assuming that operating income of $25,000 is the ROI in dollars, residual income was $(5,000). This result is consistent with defining the numerator of the ROI calculation (Income ÷ Investment) as operating income. However, it might also be defined as net profit after taxes (net income). Moreover, the ROI denominator may be defined variously, e.g., total assets available, total assets employed, working capital plus other assets, or shareholders’ equity.
Answer (A) is incorrect because The return on sales was 3.33%.
Answer (C) is incorrect because This percentage is the cost of capital.
Answer (D) is incorrect because The amount of $(20,000) assumes that ROI in dollars is $25,000 (operating income) and that the targeted amount is $45,000 ($750,000 ¡Á 6% of sales). |
Charlie’s has a