1. What is Residual Income?

Residual Income provides a way to assess how well a company is generating returns above its cost of capital. It measures the income that remains after accounting for the minimum required return on the company's operating assets.

2. How Does the Calculator Work?

The calculator uses the Residual Income formula:

Where:

• \( RI \) — Residual Income ($)
• \( OI \) — Operating Income ($)
• \( MRRR \) — Minimum Required Rate of Return (decimal)
• \( AOA \) — Average Operating Assets ($)

Explanation: The formula calculates the excess income generated by a company after meeting the minimum required return on its operating assets.

3. Importance of Residual Income

Details: Residual Income is crucial for performance evaluation, investment decision-making, and assessing whether a business unit or investment is creating value beyond the required rate of return.

4. Using the Calculator

Tips: Enter Operating Income in dollars, Minimum Required Rate of Return as a decimal (e.g., 0.4 for 40%), and Average Operating Assets in dollars. All values must be non-negative.

5. Frequently Asked Questions (FAQ)

Q1: What is the difference between Residual Income and Net Income?
A: Residual Income accounts for the cost of capital by subtracting the minimum required return, while Net Income does not consider the cost of capital.

Q2: How is Minimum Required Rate of Return determined?
A: It is typically based on the company's cost of capital or the investor's required rate of return, considering the risk profile of the investment.

Q3: What does a positive Residual Income indicate?
A: A positive Residual Income indicates that the investment or business unit is generating returns above the minimum required rate, creating value for the company.

Q4: Can Residual Income be negative?
A: Yes, negative Residual Income indicates that the investment is not meeting the minimum required return and is destroying value.

Q5: How is Residual Income used in performance evaluation?
A: It is used to evaluate the performance of business units, divisions, or investments by measuring their ability to generate returns above the cost of capital.