Lawton Industries has manufactured prefabricated houses for over 20 years. The houses are constructed in sections to be assembled on
Lawton expanded into the precut housing market in 20A when it acquired presser 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. Lawton decided to maintain Presser's separate identity and, thus, established the Presser Division as a profit center of Lawton.
Lawton uses rate of return on capital employed as a performance measure. All investments in operating assets are expected to earn a minimum return of 15% before income tax. Presser's return has ranged from 19.3% to 22.1% since it was acquired in 20A. Presser had an investment opportunity in 20F that had an estimated return on assets of 16%. Presser's management decided against the investment because it believed the investment would decrease the division's overall rate of return on capital employed.
The 20F operating statement for Presser Division is presented below. The division's operating assets employed were $12,600,000 at the end of 20F, a 5% increase over the 20E year-end balance.
(1) Calculate the following performance measures for the year 20F for the Presser Division of Lawton Industries:
(a) Rate of return on capital employed
(b) Residual income calculated on the basis of the average operating assets employed
(2) Would the management of Presser Division have been more likely to accept the investment opportunity it had in 20F if residual income were used as a performance measure instead of rate of return on capital employed? Explain.
(3) The Presser Division is a separate profit center within Lawton Industries. Identify the items Presser must control if it is to be evaluated fairly by either the rate of return on capital employed or residual income performance measures.
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