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19.Consider the following statements about residual income:

I. Residual income incorporates a firm's cost of acquiring investment capital.

II. Residual income is a percentage measure, not a dollar measure.
III. If used correctly, residual income may result in division managers making decisions that are in their
own best interest and not in the best interest of the entire firm.

Which of the above statements is (are) true?

A. I only.
B. II only.
C. I and II.
D. II and III.
E. I and III.

Answer: A LO: 2, 4 Type: RC

20. The basic idea behind residual income is to have a division maximize its:
A. earnings per share.
B. income in excess of a corporate imputed interest charge.
C. cost of capital.
D. cash flows.
E. invested capital.

Answer: B LO: 2, 4 Type: N

21.Sunrise Corporation has a return on investment of 15%. A Sunrise division, which currently has a 13% ROI and
$750,000 of residual income, is contemplating a massive new investment that will (1) reduce divisional ROI
and (2) produce $120,000 of residual income. If Sunrise strives for goal congruence, the investment:
A. should not be acquired because it reduces divisional ROI.
B. should not be acquired because it produces $120,000 of residual income.
C. should not be acquired because the division's ROI is less than the corporate ROI before the investment
is considered.
D. should be acquired because it produces $120,000 of residual income for the division.
E. should be acquired because after the acquisition, the division's ROI and residual income are both
positive numbers.

Answer: D LO: 4 Type: N

22. The Fitzhugh Division of General Enterprises has a negative residual income of $540,000. Fitzhugh's
management is contemplating an investment opportunity that will reduce this negative amount to $400,000. The
investment:
A. should be pursued because it is attractive from both the divisional and corporate perspectives.
B. should be pursued because it is attractive from the divisional perspective although not from the
corporate perspective.
C. should be pursued because it is attractive from the corporate perspective although not from the
divisional perspective.
D. should not be pursued because it is unattractive from both the divisional and corporate perspectives.
E. should not be pursued because it is unattractive from the divisional perspective although it is attractive
from the corporate perspective.

Answer: A LO: 4 Type: N

23. The Magellan Division of Global Corporation, which has income of $250,000 and an asset investment of
$1,562,500, is studying an investment opportunity that will cost $450,000 and yield a profit of $67,500.
Assuming that Global uses an imputed interest charge of 14%, would the investment be attractive to:

1—Divisional management if ROI is used to evaluate divisional performance?

2—Divisional management if residual income (RI) is used to evaluate divisional performance?
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3—The management of Global Corporation?

Attractive to Attractive to Attractive to

Magellan: ROI Magellan: RI Global
A. Yes Yes Yes
B. Yes No No
C. Yes No Yes
D. No Yes Yes
E. No Yes No

Answer: D LO: 4 Type: A, N

24. The Georgia Division of Carter Companies currently reports a profit of $3.4 million. Divisional invested
capital totals $12.5 million; the imputed interest rate is 14%. On the basis of this information, Georgia's
residual income is:
A. $476,000.
B. $1,274,000.
C. $1,650,000.
D. $1,750,000.
E. some other amount.

Answer: C LO: 2 Type: A

25. The following information relates to the Mountain Division of Adler Enterprises:

Income for the period just ended: $1,500,000

Invested capital: $12,000,000

If the firm has an imputed interest rate of 11%, Mountain's residual income would be:
A. $165,000.
B. $180,000.
C. $187,500.
D. some other dollar amount.
E. a percentage greater than 11%.

Answer: B LO: 2 Type: A

26. Extron Division reported a residual income of $200,000 for the year just ended. The division had $8,000,000
of invested capital and $1,000,000 of income. On the basis of this information, the imputed interest rate
was:
A. 2.5%.
B. 10.0%.
C. 12.5%.
D. 20.0%.
E. some other figure.

Answer: B LO: 2 Type: A

27. Barber Corporation uses an imputed interest rate of 13% in the calculation of residual income. Division X,
which is part of Barber, had invested capital of $1,200,000 and an ROI of 16%. On the basis of this
information, X's residual income was:
A. $24,960.
B. $36,000.
C. $156,000.
D. $192,000.
E. some other amount.

Answer: B LO: 2 Type: A, N

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