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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 14 percent before income taxes. Fairmont’s ROI has ranged from 29.2 to 32.4 percent since it was acquired. Fairmont had an investment opportunity in 20x1 that had an estimated ROI of 28 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 $18,900,000 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 $ 68,070 Cost of goods sold 41,600 Gross margin $ 26,470 Operating expenses: Administrative $ 5,280 Selling 15,655 20,935 Income from operations before income taxes $ 5,535

Explanation / Answer

1(a)Calculate the return on Investment (ROI) for 20x1for the Fairmont Division

ROI = (Net operating Income / Average Assets)*100

Net Operating Income = $55,35,000

Ending Assets = $1,89,00,000

Beginning Assets = $1,89,00,000 / 1.05 = $1,80,00,000

Average Assets = ($1,89,00,000 + $1,80,00,000) / 2 = $1,84,50,000

Therefore, ROI = ($55,35,000 / $1,84,50,000) x 100

                         = 30%

1(b)-Residual Income

= Net Operating Income – Minimum required return

= $55,35,000 – ($1,84,50,000 x 14%)

= $55,35,000 - $2583000

= $29,52,000

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