Wyalusing Industries has manufactured prefabricated houses for over 20 years

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 15 percent

before income taxes. Fairmont’s ROI has ranged from 19.3 to 22.1 percent since it was acquired. Fairmont

had an investment opportunity in 20×1 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 20×1 income statement for Fairmont Division follows. The division’s productive assets were

$12,600,000 at the end of 20×1, a 5 percent increase over the balance at the beginning of the year.

FAIRMONT DIVISION

Income Statement

For the Year Ended December 31, 20×1

(in thousands)

Sales revenue ………………………………………………………………………………………………………………………………. $24,000

Cost of goods sold …………………………………………………………………………………………………………………………. 15,800

Gross margin ……………………………………………………………………………………………………………………………. $ 8,200

Operating expenses:

Administrative ……………………………………………………………………………………………………………. $2,140

Selling ………………………………………………………………………………………………………………………. 3,600 5,740

Income from operations before income taxes ………………………………………………………………………………………. $ 2,460

 

Required:

1. Calculate the following performance measures for 20×1 for the Fairmont Division.

a. Return on investment (ROI).

b. Residual income.

2. Would the management of Fairmont Division have been more likely to accept the investment

opportunity it had in 20×1 if residual income were used as a performance measure instead of ROI?

Explain your answer.