Wyalusing Industries manufactured prefabricated house. They expanded into pre-cut housing when it acquired Fairmont. Wyalusing uses ROI as a performance measure with investment defined as average productive assets. Management bonuses are based in part of the return on investment (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 % since it was acquired. Fairmont had an investment opportunity in 20x1 that had an estimated ROI of 18%. However, they decided against the investment because they felt it would decrease the overall ROI.
The 20x1 income statement for Fairmont division is as follows.
The division productive assets were $12,600,000 at the end of 20x1 a 5% increase over the beginning of the year balance.
Year ended 12/31/20x1
Sales revenue - $24,000,000
Cost of good sold $15,800,000
Gross Margin $8,200,000
Income from operations before income taxes - $2,460,000
1. Calculate ROI and Residual Income.
2. Show how the solution will change if income from operations was $2,700,000
This solution provides guidelines on calculating the return on investment and residual income.