Sentinel Industries has manufactured prefabricated houses for
over 20 years. The houses are constructed in sections to be
assembled on customers’ lots. Sentinel expanded into the precut
housing market when it acquired Jensen 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. Sentinel designated the Jensen
Division as an investment center.
Sentinel uses return on investment (ROI) as a performance measure
with investment defined as average operating assets. Management
bonuses are based in part on ROI. All investments are expected to
earn a minimum rate of return of 17.6%. Jensen’s ROI has ranged
from 20.2% to 23.3% since it was acquired. Jensen had an investment
opportunity in 2020 that had an estimated ROI of 19.1%. Jensen
management decided against the investment because it believed the
investment would decrease the division’s overall ROI.
Selected financial information for Jensen are presented below. The
division’s average operating assets were $12,567,000 for the year
2020.
|
SENTINEL INDUSTRIES |
||
| Sales | $25,483,000 | |
| Contribution margin | 8,966,000 | |
| Controllable margin | 2,525,967 | |
Calculate the following performance measures for 2020 for the
Jensen Division. (Round ROI to 1 decimal place, e.g.
1.5.)
| (1) | Return on investment (ROI) | % | |||
| (2) | Residual income | $ |
(a)
(1) ROI = Controllable margin** / Average operating assets
= $2,525,967 / $12,567,000
= 0.201
= 20.10%
(2) Residual income (RI) = Controllable margin** - (Average operating assets x Minimum rate of return)
= $2,525,967- ($12,567,000 x 17.6%)
= $(2,525,967 - 221179.2)
= $314175
-Since divisional performance is being analyzed, we use the earning (margin) that is controllable by the division and not overall contribution margin.
(b)
Since Residual income is positive in 2020, Jensen would most likely accept the investment opportunity.
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