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 18%. Jensen’s ROI has ranged from 20.1% to 23.5% since it was acquired.
Jensen had an investment opportunity in 2020 that had an estimated ROI of 19%. 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 $12,300,000 for the year 2020.
Sentinel Industries
Jensen Division
Selected Financial Information
For the Year Ended December 31, 2020
Sales ………………………………. $24,000,000
Contribution margin ………… 9,100,000
Controllable margin …………. 2,460,000
Instructions
a. Calculate the following performance measures for 2020 for the Jensen Division.
1. Return on investment (ROI).
2. Residual income.
b. Would the management of Jensen Division have been more likely to accept the investment opportunity it had in 2020 if residual income were used as a performance measure instead of ROI? Explain your answer.
