1. What is Residual Income?

Residual income is the amount of income remaining after accounting for the cost of capital. It represents the profit remaining after deducting not just operating expenses, but also the cost of capital employed in the business.

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 a key metric in corporate finance and investment analysis. It helps evaluate whether a company is generating returns above its cost of capital, which is crucial for value creation.

4. Using the Calculator

Tips: Enter net income and equity in currency units, and required return as a decimal (e.g., 0.12 for 12%). All values must be valid (non-negative, required return between 0-1).

5. Frequently Asked Questions (FAQ)

Q1: How is residual income different from net income?
A: Net income shows absolute profitability, while residual income shows profitability after accounting for the cost of capital.

Q2: What's a good residual income value?
A: Positive values indicate value creation (returns above cost of capital), while negative values indicate value destruction.

Q3: How is required return determined?
A: It's typically based on the company's cost of equity, often calculated using models like CAPM.

Q4: Can residual income be negative?
A: Yes, when returns are below the cost of capital, residual income will be negative.

Q5: How does this relate to EVA (Economic Value Added)?
A: EVA is a similar concept but typically uses after-tax operating profit and total capital (not just equity).