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 14 percent before income taxes. Fairmont's ROI has ranged from 23.3 to 26.5 percent since it was acquired. Fairmont had an investment opportunity in 20x1 that had an estimated ROl of 22 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 $10,500,000 at the end of 20x1, a 5 percent increase over the balance at the beginning of the year. FAIRMONT DIVISION Income Statement For the Year Ended December 31, 20x1 (in thousands) Sales revenue $57,920 39,600 Cost of goods sold Gross margin Operating expenses: $18,320 $ 5,080 Administrative 10,780 15,860 Selling $2,460 Income from operations before income taxes

Calculate the ROI and Residual Income.

Answer 1

ROI Productive Assets At Beginning $ 1,05,00,000 $ 1,10,25,000 Productive Assets At End of Year (10500000+5%) $ 1,07,62,500 Therefore Average Productive Assets (a+b/2) ROI = Income from operations before income taxes / Average Productive Assets =2460000/10762500 22.857% or 22.86%

Residual Income = Income from operations before income taxes- minimum required return =2460000-(14% *10762500) =2460000-1506750 =$953250