Question Completion:
1. Jarriot's expected minimum rate of return is 10%.
2. Four alternatives: a. The Espresso-Pro is added. $ b. The Mini-Prep is added. $ c. Both investments are added. $ d. Neither investment is made; the status quo is maintained.
Answer:
Jarriot, Inc.
Household Division:
1. Residual income for each of the opportunities:
Espresso-Pro Mini-Pro Total
Residual income $2,500 ($1,000) $1,500
2. Residual income for the four alternatives:
a. The Espresso-Pro is added. $2,500
b. The Mini-Prep is added. ($1,000)
c. Both investments are added. $1,500
d. Neither investment is made; the status quo is maintained. $0.
Explanation:
a) Data and Calculations:
Residual income:
Furniture Division:
Year 1 Year 2
Sales $35,000,000 $37,500,000
Operating income 1,400,000 1,500,000
Average operating assets 10,000,000 10,000,000
Rate of return (10%) 1,000,000 1,000,000
Residual income $400,000 $500,000
Houseware Division:
Year 1 Year 2
Sales $12,000,000 $12,500,000
Operating income 600,000 500,000
Average operating assets 5,000,000 5,000,000
Rate of return (10%) 500,000 500,000
Residual income $100,000 $0
Residual income for each of the opportunities:
Espresso-Pro Mini-Pro
Operating income $ 27,500 $19,000
Outlay 250,000 200,000
Rate of return (10%) 25,000 20,000
Residual income $2,500 ($1,000)
Year 2 Espresso-Pro Total
Sales $12,500,000
Operating income 500,000 $27,500 $527,500
Average operating assets 5,000,000 250,000 5,250,000
Rate of return (10%) 500,000 25,000 525,000
Residual income $0 $2,500 $2,500
Year 2 Mini-Pro Total
Sales $12,500,000
Operating income 500,000 $19,000 $519,000
Average operating assets 5,000,000 200,000 5,200,000
Rate of return (10%) 500,000 20,000 520,000
Residual income $0 ($1,000) ($1,000)
b) Residual income is the difference between the operating income and the cost of capital (or the minimum required return). It is the income that is left after taking into consideration, the stockholders' opportunity cost of generating the income.