Question

Felton Co. produces rubber bands for commercial and home use. Felton reported $8 million residual income (RI) with $25 million net book value (NBV) of assets and $13 million in operating income for the year. What was the required rate of return?

Answer 1

Answer:

Residual income = Operating income - (r x Asset invested)

            $8 million = $13 million - (r x  25 million)

             $8 million = $13 million - r25 million              

              r25 million = $13 million - $8 million

              r25 million = $5 million

              r                 = $5 million/25 million

              r                 = 0.2 = 20%

            Thus, required rate of return is 20%

Explanation:

In this case, we need to apply the residual income formula. Operating income, asset invested and residual income have been given with the exception of rate of return. Thus, rate of return becomes the subject of the formula.