1. What is Residual Income?

Residual income is the amount of income that remains after accounting for the cost of capital. It measures economic profit by subtracting the opportunity cost of equity capital from net income.

2. How Does the Calculator Work?

The calculator uses the residual income formula:

Where:

• \( \text{Net Income} \) — The company's total earnings after all expenses
• \( \text{Equity} \) — The shareholders' equity or invested capital
• \( \text{Required Return} \) — The minimum expected return on equity (as decimal)

Explanation: The formula shows how much income exceeds the minimum required return on invested capital.

3. Importance of Residual Income

Details: Residual income is important for evaluating company performance, investment decisions, and value-based management. Positive residual income indicates value creation.

4. Using the Calculator

Tips: Enter net income and equity in dollars, required return as a decimal (e.g., 0.10 for 10%). All values must be non-negative.

5. Frequently Asked Questions (FAQ)

Q1: How is residual income different from net income?
A: Residual income accounts for the cost of capital, showing true economic profit, while net income doesn't consider capital costs.

Q2: What's a good residual income value?
A: Positive values indicate value creation. Higher positive values are better, showing greater returns above the required rate.

Q3: How does residual income relate to ROI?
A: Residual income considers absolute dollar amounts, while ROI is a percentage. Both measure performance but in different ways.

Q4: Can residual income be negative?
A: Yes, negative residual income means the investment isn't meeting its required return threshold.

Q5: How is residual income used in valuation?
A: It's used in residual income valuation models to estimate intrinsic value by discounting future residual incomes.