Exercise 13-29 ROI; Residual Income (LO 13-1, 13-2) [The following information a

Question

Exercise 13-29 ROI; Residual Income (LO 13-1, 13-2)

[The following information applies to the questions displayed below.]

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 19.3 to 22.5 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 $37,800,000 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 $ 63,760 Cost of goods sold 36,100 Gross margin $ 27,660 Operating expenses: Administrative $ 4,730 Selling 15,550 20,280 Income from operations before income taxes $ 7,380

Explanation / Answer

Average productive assets =37800000+(37800000/105*100)/2= 36900000 1a Return on investment (ROI) = Income from operations before income taxes /Average assets =7380000/36900000= 20% b Residual income = 7380000-(36900000*14%)= 2214000

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