The historical weighted average cost of capital for the company may be used in residual income calculation only if it is set as a target rate of return. Otherwise, this past figure is irrelevant to the evaluation of future managerial performance.
The marginal after-tax cost of new equity capital may be used in the residual income calculation only if it is set as a target rate of return. Otherwise, this past figure is irrelevant to the evaluation of future managerial performance.
The average return on investment that has been earned by the company over a particular period may be used in residual income calculation only if it is set as a target rate of return. Otherwise, this past figure is irrelevant to the evaluation of future managerial performance.
In the calculation of residual income, management normally sets a desired target rate of return that it wants to achieve. The target rate of return may be set based prior experience or any other estimation depending on management's decision.
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