Wyalusing Industries has manufactured prefabricated houses for over 20 years. Th
ID: 2528978 • Letter: W
Question
Wyalusing Industries has manufactured prefabricated houses for over 20 years. The houses are constructed in sections to be assembled on customers’ lots. Wyalusing expanded into the precut housing market when it acquired Fairmont Company, one of its suppliers. In this market, various types of lumber are precut into the appropriate lengths, banded into packages, and shipped to customers’ lots for assembly. Wyalusing designated the Fairmont Division as an investment center. Wyalusing uses return on investment (ROI) as a performance measure with investment defined as average productive assets. Management bonuses are based in part on ROI. All investments are expected to earn a minimum return of 16 percent before income taxes. Fairmont’s ROI has ranged from 19.2 to 22.4 percent since it was acquired. Fairmont had an investment opportunity in 20x1 that had an estimated ROI of 18 percent. Fairmont’s management decided against the investment because it believed the investment would decrease the division’s overall ROI. The 20x1 income statement for Fairmont Division follows. The division’s productive assets were $39,900,000 at the end of 20x1, a 5 percent increase over the balance at the beginning of the year.
Required:
1-a. Calculate the return on investment (ROI) for 20x1 for the Fairmont Division.
1-b. Calculate residual income for 20x1 for the Fairmont Division.
FAIRMONT DIVISION Income Statement For the Year Ended December 31, 20x1 (in thousands) Sales revenue $ 65,580 Cost of goods sold 36,600 Gross margin $ 28,980 Operating expenses: Administrative $ 4,780 Selling 16,410 21,190 Income from operations before income taxes $ 7,790Explanation / Answer
1(a)Calculate the return on Investment (ROI) for 20x1for the Fairmont Division
ROI = (Net operating Income / Average Assets)*100
Net Operating Income = $77,90,000
Ending Assets = $3,99,00,000
Beginning Assets = $3,99,00,000 / 0.105 = $3,80,00,000
Average Assets = ($3,99,00,000 + $3,80,00,000) / 2 = $3,89,50,000
Therefore, ROI = ($77,90,000/$3,89,50,000) x 100
= 20%
1(b)-Residual Income
= $77,90,000 – ($3,89,50,000 x 18%)
= $77,90,000 – $70,11,000
= $7,79,000
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