What is the residual income?
Enter the profit a division or project earns, the capital it uses and the lowest return your company accepts. The calculator takes the required return on the capital off the profit to give the residual income, and shows the ROI beside it.
- Residual income
- $5,470,000.00
Earning $7,000,000.00 on $10,200,000.00 of capital at a 15% required return leaves a residual income of $5,470,000.00.
Earns at least the required return
- Earns less than the required return
- Earns at least the required return
- Capital charge (required return)
- $1,530,000.00
- Invested capital used
- $10,200,000.00
- Return on investment (ROI)
- 68.63%
Residual income: $5,470,000.00. Earning $7,000,000.00 on $10,200,000.00 of capital at a 15% required return leaves a residual income of $5,470,000.00.
The results are estimates for information only. They are not financial, tax, or legal advice. Check the numbers with your lender or a qualified professional before you decide. Terms of use
How to calculate
Computes the residual income of a division or project: its operating income minus the minimum required return on its invested capital, with the capital charge and ROI.
Example with the default inputs (Operating income (profit) $7,000,000.00, Invested capital One amount, Invested capital (operating assets) $10,200,000.00, Minimum required rate of return 15%): Earning $7,000,000.00 on $10,200,000.00 of capital at a 15% required return leaves a residual income of $5,470,000.00.
Method: RI = operating income − invested capital × minimum required rate of return; ROI = operating income ÷ invested capital.
- Income and capital are measured the same way your company measures them for its divisions (for example net book value).
- The average capital is (start + end) ÷ 2 for the year.
- Arithmetic is exact on the typed decimals; money rounds once to the cent and the ROI to 2 decimals.
Worked examples
Each example is checked against the calculator on every build.
- Operating income (profit) $250,000.00, Invested capital One amount, Invested capital (operating assets) $1,500,000.00, Minimum required rate of return 18% gives Residual income -$20,000.00, Capital charge (required return) $270,000.00, Return on investment (ROI) 16.666667%.Source: OpenStax, Principles of Accounting, Volume 2: Managerial Accounting, 12.3 Evaluate an Operating Segment or a Project Using Return on Investment, Residual Income, and Economic Value Added (RI = profit − invested capital × minimum required rate of return; average capital = (start + end) ÷ 2). https://openstax.org/books/principles-managerial-accounting/pages/12-3-evaluate-an-operating-segment-or-a-project-using-return-on-investment-residual-income-and-economic-value-added: $250,000 − ($1,500,000 × 0.18) = −$20,000
- Operating income (profit) $7,000,000.00, Invested capital Average of start and end, Capital at the start of the year $10,000,000.00, Capital at the end of the year $10,400,000.00, Minimum required rate of return 15% gives Residual income $5,470,000.00, Invested capital used $10,200,000.00, Return on investment (ROI) 68.627451%.Source: OpenStax, Principles of Accounting, Volume 2: Managerial Accounting, 12.3 Evaluate an Operating Segment or a Project Using Return on Investment, Residual Income, and Economic Value Added (RI = profit − invested capital × minimum required rate of return; average capital = (start + end) ÷ 2). https://openstax.org/books/principles-managerial-accounting/pages/12-3-evaluate-an-operating-segment-or-a-project-using-return-on-investment-residual-income-and-economic-value-added: $7,000,000 − ($10,200,000 × 0.15) = $5,470,000
- Operating income (profit) $8,000,000.00, Invested capital Average of start and end, Capital at the start of the year $12,000,000.00, Capital at the end of the year $12,400,000.00, Minimum required rate of return 15% gives Residual income $6,170,000.00, Invested capital used $12,200,000.00, Return on investment (ROI) 65.57377%.Source: OpenStax, Principles of Accounting, Volume 2: Managerial Accounting, 12.3 Evaluate an Operating Segment or a Project Using Return on Investment, Residual Income, and Economic Value Added (RI = profit − invested capital × minimum required rate of return; average capital = (start + end) ÷ 2). https://openstax.org/books/principles-managerial-accounting/pages/12-3-evaluate-an-operating-segment-or-a-project-using-return-on-investment-residual-income-and-economic-value-added: $8,000,000 − ($12,200,000 × 0.15) = $6,170,000
How it works
With the operating income I, the invested capital C and the minimum required rate of return r (a percent):
- Capital charge = C × r ÷ 100
- Residual income RI = I − C × r ÷ 100
- ROI = I ÷ C × 100
With "Average of start and end", the invested capital is C = (capital at the start + capital at the end) ÷ 2.
RI is at least $0 exactly when the ROI is at least the required rate, because RI = C × (ROI − r) ÷ 100.
Rules:
- The income may be negative (a loss), from −$1 quadrillion to $1 quadrillion. Capital amounts are from $0 to $1 quadrillion, and the required rate from 0% to 1,000%.
- With no capital ($0), the charge is $0, the RI equals the income and there is no ROI.
- The arithmetic is exact on the decimals you type. Money shows to the cent and the ROI to 2 decimals, with halves rounded up (away from 0).
- A result too large for a 64-bit floating-point number gives no answer and a message. So does a result that is not $0 but too close to $0 for one (about 2.5 × 10⁻³²⁴ or less): the capital charge, the residual income and the ROI are never a silent $0 (or 0%).
Assumptions
- Income and capital are measured the way your company measures its divisions, for example capital at net book value.
- The required rate is a yearly rate and the income is for one year.
Worked examples by hand
OpenStax's donut machine. It costs $1,500,000 and is expected to earn $250,000, at an 18% required return. Capital charge = 1,500,000 × 0.18 = $270,000. RI = 250,000 − 270,000 = −$20,000, so on RI alone the manager would turn it down. Its ROI is 250,000 ÷ 1,500,000 = 16.67%, below 18%.
SkyHigh Superball, without the new machine. Capital of $10,000,000 at the start and $10,400,000 at the end averages $10,200,000. With $7,000,000 of income at 15%: RI = 7,000,000 − 10,200,000 × 0.15 = 7,000,000 − 1,530,000 = $5,470,000. ROI = 7,000,000 ÷ 10,200,000 = 68.63% (OpenStax rounds to 69%).
SkyHigh Superball, with the machine. Capital averages (12,000,000 + 12,400,000) ÷ 2 = $12,200,000 and income is $8,000,000: RI = 8,000,000 − 1,830,000 = $6,170,000, higher than without it, although the ROI falls to 65.57% (OpenStax: 66%).
Other questions people ask
What is residual income?
Residual income (RI) is the profit a division or project earns above the minimum return the company requires on the capital it uses. A positive RI means it earns more than that minimum; a negative RI means it falls short.
How do I calculate residual income?
Multiply the invested capital by the minimum required rate of return to get the capital charge, then subtract the charge from the operating income. A $1,500,000 machine that earns $250,000 at an 18% required return has RI = 250,000 − 1,500,000 × 0.18 = −$20,000.
What is the difference between residual income and ROI?
ROI is a percent: income ÷ invested capital. Residual income is a dollar amount above a required return. A division with a high ROI may turn down a project whose ROI is lower than its own but still above the company’s required rate; that project still has a positive residual income.
What required rate of return should I use?
The rate your company sets as the minimum return on its projects and investments. It is often close to the company’s cost of capital, but it can be higher.
Should I use average capital or year-end capital?
Use the measure your company uses for its divisions. A common choice is the average of the capital at the start and the end of the year, so a division is not judged on one day’s balance. Choose "Average of start and end" to use it.
Is residual income the same as economic value added (EVA)?
EVA is a close relative: after-tax income minus invested capital times the weighted average cost of capital (WACC). Type after-tax income and the WACC here to get EVA. A machine that earns $150,000 after tax on $1,500,000 at a 9% WACC has an EVA of 150,000 − 135,000 = $15,000.