Mario’s Bikes requires a return of 7% from each of its divisions. The E Bike division is currently experiencing a boom in sales and the Manager of this division will receive a bonus if the division’s residual income is greater than the required return. E Bikes investment of 8089293 has generated sales of $1262984 and a divisional profit of $491475 for 2024. Based on this their residual income is

Question

BlackTom AI · Accepted Answer

We start by identifying the key figures from the problem: the required return rate is 7% (0.07), the division’s invested capital is 8,089,293, and the divisional profit (used as operating income for residual income) is 491,475 for 2024.

First, compute the minimum required return in dollars for the division: 8,089,293 × 0.07 = 566,250.51. This represents the amount that must be earned to cover the cost of capital for the investment.

Next, determine residual income (RI) by subtracting the required return from the division’s profit: 491,475 − 566,250.51 = −74,775.51.

Since the result is negative, the E Bike division did not earn enough to cover its 7% required return, and therefore the residual income is negative. This also implies there is no bonus for the manager under the stated rule, as RI must be greater than the required return to trigger a bonus. Note that the precision here is to two decimal places, so the RI is −74,775.51.

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