Question

TE10-7 Evaluating Managerial Performance Using Return on Investment, Residual Income [LO 10-4, 10-5]

Orange Corp. has two divisions: Fruit and Flower. The following information for the past year is available for each division:

	Fruit Division			Flower Division
Sales revenue	$	1,320,000		$	1,980,000
Cost of goods sold and operating expenses		990,000			1,485,000
Net operating income	$	330,000		$	495,000
Average invested assets	$	5,000,000		$	1,980,000

   

Orange has established a hurdle rate of 5 percent.   

Required:
1-a. Compute each division’s return on investment (ROI) and residual income for last year. (Enter your ROI answers as a percentage rounded to two decimal places, (i.e., 0.1234 should be entered as 12.34%.))

ROI:

Residual Income:

1-b. Determine which manager seems to be performing better.

        

	Fruit Division
	Flower Division

   

2. Suppose Orange is investing in new technology that will increase each division’s operating income by $142,000. The total investment required is $2,100,000, which will be split evenly between the two divisions. Calculate the ROI and return on investment for each division after the investment is made. (Enter your ROI answers as a percentage rounded to two decimal places, (i.e., 0.1234 should be entered as 12.34%.))

ROI :?

Residual Income (Loss) :?

3. Which manager will accept the investment.

Fruit or flower?

Answer 1

SOLUTION

1. Return on investment = Net operating income / Average invested assets

Fruit division-

Return on investment = $330,000 / 5,000,000 = 6.6%

Flower division-

Return on investment = $495,000 / 1,980,000 = 25%

Residual Income = Net operating income - (Average invested assets * Minimum rate of return)

Fruit division-

Return on investment = $330,000 - (5,000,000*6%)

= $330,000 - 300,000 = $30,000

Flower division-

Return on investment = $495,000 - (1,980,000*6%)

= $495,000 - 118,800 = $376,200

1B. Flower division performs better.

2. New Operating income-

Fruit division = 330,000+ 142,000 = 472,000

Flower division = 495,000 + 142,000 = 637,000

New average invested assets -

Fruit division = 5,000,000 + 1,050,000 = 6,050,000

Flower division = 1,980,000 + 1,050,000 = 3,030,000

ROI -

Fruit division = 472,000 / 6,050,000 = 7.80%

Flower division = 637,000 / 3,030,000 = 21.02%

Residual income-

Fruit division = 472,000 - (6,050,000*6%) = 109,000

Flower division = 637,000 - (3,030,000 *6%) = 455,200

3. Fruit divsion manager will accept.