Requlred Informetlon The following information applies to the questions displaye

Question

Requlred Informetlon 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 Falrmont Company, one of its suppliers. In this market, various types of lumber are precut Into the approprlate lengths, banded Into packages, and shlpped to customers' lots for assembly. Wyalusing designated the Falrmont 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 ROl. All Investments are expected to earn a minimum return of 14 percent before Income taxes. Falrmont's ROl has ranged from 25.7 to 28.9 percent sSince It was acquired. Falrmont had an Investment opportunity In 20x1 that had an estimated ROl of 24 percent Fairmont's management declded agalnst the Investment because It belleved the Investment would decrease the divislon's overall ROI. The 20x1 Income statement for Falrmont Divislon follows. The division's productive assets were $31,500,000 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, 28x1 (in thousands) Sales revenue Cost of goods sold 565,998 34,688 531, 398 Gross margin Operating expenses $4, 580 Administrative Selling 18,815 23,395 57,995 Income From operations before income taxes Required: 1-a. Calculate the return on Investment (ROI) for 20x1 for the Falrmont DIvislon. 1-b. Calculate residual Income for 20x1 for the Falrmont DIvision.

Explanation / Answer

1-a Return on investment = Income from operations before income taxes / Average assets

where, Average assets = opening assets + closing assets /2 = 3150000+5%of 3150000 + 31500000 /2

= 33075000+ 31500000/2= 32287500

Return on investment = 7995000/32287500 = 24%

1-b Residual income = Income from operations before income taxes - (Assets * requires rate of return)

= 7995000- (31500000*14%)

= 7995000 - 4410000= $3585000

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