Answer: -$30,000

## Calculation Explanation **Step 1: Calculate the after-tax cost of debt** - Cost of debt before tax: 6% - Tax rate: 25% - After-tax cost of debt = 6% × (1 - 0.25) = 4.5% **Step 2: Calculate the weighted average cost of capital (WACC)** - Total capital = $4,000,000 + $6,000,000 = $10,000,000 - Weight of debt = $4,000,000 / $10,000,000 = 0.4 - Weight of equity = $6,000,000 / $10,000,000 = 0.6 - WACC = (0.4 × 4.5%) + (0.6 × 10%) = 1.8% + 6% = 7.8% **Step 3: Calculate the required return** - Required return = Total capital × WACC = $10,000,000 × 7.8% = $780,000 **Step 4: Calculate residual income** - Residual income = Net operating profit after tax - Required return - Residual income = $750,000 - $780,000 = -$30,000 The company's residual income is -$30,000, indicating it is not covering its cost of capital.

Author: LeetQuiz Editorial Team