ACC 117 Lecture Notes - Lecture 20: Economic Value Added, Market Price, Transfer Pricing
24 Jul 2020
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Residual income = operating income - (minimum rate of return*average operating assets) Less than zero, the company is earning less than minimum roi. Exactly zero, the company is earning precisely minimum roi. Greater than zero, the company is earning more than minimum roi. Encourages managers to accept any project that earns above minimum rate. Residual income is an absolute measure of profitability. Direct comparison is difficult when levels of investments differ. Formula: after-tax operating income - (actual percentage cost of capital * total capital employed) If eva is positive, then company is creating wealth. If eva is negative, then company is destroying wealth. If a division builds up inventory and investment, then the cost of financing that investment is reflected in the divisions income. The transfer price is the price charged for a component by the selling division to the buying division of the same company. Sale is a revenue to the selling division.
