Answer:
a. What is Forbes Division's residual income if Oscar does not acquire the new machine?
residual income = $3,550,000 - ($6,160,000 x 12%) = $2,810,800
b. What is Forbes Division's residual income this year if Oscar acquires the new machine?
residual income = $70,000 - ($9,190,000 x 12%) = -$1,032,800
c. If Oscar acquires the new machine and operates it according to specifications, what residual income is expected for next year?
residual income = $5,167,000 - ($5,833,000 x 12%) = $4,467,040
In order to calculate net income, I assumed other depreciation remained the same for both years.
Explanation:
residual income = net income - (capital x cost of capital)
if new machine is not purchased:
net income = $3,550,000
cost of capital = 12%
capital = ($4,060,000 + $5,080,000) - depreciation $2,980,000 = $6,160,000
if new machine is purchased, current year's residual income
net income = $3,550,000 - $3,480,000 loss on disposal = $70,000
capital = ($4,060,000 + $5,080,000 + $6,510,000) - $5,080,000 - $1,380,000 = $9,190,000
if new machine is purchased, calculations for next year
net income:
sales revenue $17,754,000
variable costs ($2,010,000)
Fixed (all cash) ($7,220,000)
depreciation new machine ($1,977,000)
depreciation other ($1,380,000)
loss on disposal new machine ($3,480,000)
net income = $5,167,000
cost of capital = 12%
capital = ($2,680,000 + $6,510,000) - depreciation ($1,380,000 + $1,977,000) = $5,833,000
residual income = $5,167,000 - ($5,833,000 x 12%) = $4,467,040
