Luton Homes is a leading builder of luxury houses. Three years ago, Luton expanded its business by

Fantastic news! We've Found the answer you've been seeking!

Question:

Luton Homes is a leading builder of luxury houses. Three years ago, Luton expanded its business by acquiring Clarity Homes, which gave Luton a significant presence in the project home market. Clarity is managed as an investment centre, and ROI is used to assess Clarity’s performance (with the average of beginning and end-of-year investment balances being used in the ROI calculation). Bonuses for Clarity’s managers are also based in part on ROI.
Investments made by Luton Homes and its Clarity division are expected to earn a minimum return of 15 per cent before income taxes. Clarity’s ROI has ranged from 19.3 to 22.1 per cent since it was acquired. Last year, Clarity considered an investment opportunity with an estimated ROI of 18 per cent. Clarity’s management decided against the investment because they believed it would decrease their overall ROI. Last year’s profit statement for Clarity is provided below. The division’s productive assets were $37 800 000 at year end, a 5 per cent increase over the prior year-end balance Profit statement Sales revenue Cost of goods sold Gross margin Operating costs: Administrative Clarity Homes

Profit statement Sales revenue Cost of goods sold Gross margin Operating costs: Administrative Clarity Homes

Required:

1.Calculate the following performance measures for last year for the Clarity Homes division:

1.(a)return on investment (ROI)

2.(b)residual income.

2. Would the management of the Clarity Homes division have been more likely to accept the investment opportunity if residual income had been used as a performance measure instead of ROI? Explain your answer.

3. Construct an Excel spreadsheet to show how the answers to requirement 1 will change if: 1.

(a)profit from operations was $8 100 000 2.

(b)productive assets at year-end were $ 54,000,000.