Question

Sherwin Corporation has three business segments: paint, wallpapers, and tools. The company's assumed

cost of capital is 10%. Financial information about each segment follows.

Paint Segment Wallpaper Segment Tools Segment

	Paint Segment	Wallpaper Segment	Tools Segment
Segment operating income	$680,000	$480,000	$800,000
Invested capital	6,000,000	3,800,000	8,000,000

(a) Calculate residual income for each segment.

(b) Assuming a reduction in assumed cost of capital to 5%, prepare a revised analysis of residual

income. Does this revised assumption alter the rankings?

	A.	4(a) Paint Residual income $90,000 4(a) Wallpaper Residual income $110,000 4(a) Tools Residual income $10 4(b) Paint Residual income $390,000 4(b) Wallpaper Residual income $295,000 4(b) Tools Residual income $403,000
	B.	4(a) Paint Residual income $80,000 4(a) Wallpaper Residual income $100,000 4(a) Tools Residual income $0 4(b) Paint Residual income $380,000 4(b) Wallpaper Residual income $290,000 4(b) Tools Residual income $400,000
	C.	4(a) Paint Residual income $78,000 4(a) Wallpaper Residual income $96,000 4(a) Tools Residual income $30 4(b) Paint Residual income $240,000 4(b) Wallpaper Residual income $267,000 4(b) Tools Residual income $360,000
	D.	4(a) Paint Residual income $88,000 4(a) Wallpaper Residual income $106,000 4(a) Tools Residual income $40 4(b) Paint Residual income $260,000 4(b) Wallpaper Residual income $160,000 4(b) Tools Residual income $240,000
	E.	4(a) Paint Residual income $66,000 4(a) Wallpaper Residual income $76,000 4(a) Tools Residual income $70 4(b) Paint Residual income $385,000 4(b) Wallpaper Residual income $293,000 4(b) Tools Residual income $409,000
	F.	None of the above

Answer 1

Residual Income = Operating income - Average Invested Assets*Required rate of return
	Paint	Wallpaper	Tools
RI	80000	100000	0
4b	380000	290000	400000
Yes, will alter
Answer is B

B D 1 Residual Income = 0 2 Paint Wallpaper Tools 3 RI =680000-6000000*10% =480000-3800000*10% =800000 - 8000000* 10% 4 4b =680000-6000000*5% =480000-3800000*5% =800000 - 8000000*5% 5 Yes, will alter 6 Answer is B 7