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Refer to the data given in Exercise 10.8. Required: 1. Compute the residual income for each of the opportunities. (Round to the nearest dollar.) 2. Compute the divisional residual income (rounded to the nearest dollar) for each of the following 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. Assuming that divisional managers are evaluated and rewarded on the basis of residual income, which alternative do you think the divisional manager will choose? 3. Based on your answer in Requirement 2, compute the profit or loss from the divisional manager’s investment decision. Was the correct decision made?

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Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663

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Section
BuyFindarrow_forward

Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663
Chapter 10, Problem 9E
Textbook Problem
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Refer to the data given in Exercise 10.8.

Required:

  1. 1. Compute the residual income for each of the opportunities. (Round to the nearest dollar.)
  2. 2. Compute the divisional residual income (rounded to the nearest dollar) for each of the following four alternatives:
    1. a. The Espresso-Pro is added.
    2. b. The Mini-Prep is added.
    3. c. Both investments are added.
    4. d. Neither investment is made; the status quo is maintained.

Assuming that divisional managers are evaluated and rewarded on the basis of residual income, which alternative do you think the divisional manager will choose?

  1. 3. Based on your answer in Requirement 2, compute the profit or loss from the divisional manager’s investment decision. Was the correct decision made?

1.

To determine

Compute the residual income for each of the investment opportunity.

Explanation of Solution

Residual income: It is an amount by which an operating income (earnings) exceeds a minimum acceptable return on the average capital invested.

Residual income=Operating earnings(Minimum acceptable return×Invested capital)

Compute the residual income:

For Investment EP:

Residual income=Operating earnings(Minimum acceptable return×Invested capital)=$27,500(9%×$250,000)=$27,500$22,500=$5,000

Therefore, the residual income is $5,000

2.

To determine

Compute the divisional residual income for each of the given alternative investments. And identify the investment that the divisional manager will choose.

3.

To determine

Compute the profit or loss from the divisional manager’s investment decision and identify whether the decision is correct or not.

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Chapter 10 Solutions

Cornerstones of Cost Management (Cornerstones Series)
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