Question

In: Accounting

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

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 $ 1,020,000 $ 1,530,000
Cost of goods sold and operating expenses 765,000 1,147,500
Net operating income $ 255,000 $ 382,500
Average invested assets $ 2,550,000 $ 2,250,000



Orange has established a hurdle rate of 8 percent.

Required:
1-a. Compute each division’s return on investment (ROI) and residual income for last year.
1-b. Determine which manager seems to be performing better.
2. Suppose Orange is investing in new technology that will increase each division’s operating income by $132,000. The total investment required is $2,100,000, which will be split evenly between the two divisions. Calculate the ROI and residual income for each division after the investment is made.
3. Determine whether both managers will support the investment.

Solutions

Expert Solution

1

a)

ROI=net icome/average op assets
Fruits ROI=255000/2550000=10%
Flowers ROI=382500/2250000=17%

Residual income (RI) = Operating Income-(Operating Assets x Target Rate of Return)
Residual income for fruits =255000-(2550000*8%)=$51,000


Residual income for flowers =382500-(2250000*8%)=$202500

b) Flowers division manager is seems to be doing better

2)

Increase in each division’s operating income = $132,000.

Increase in each divison's total investment = $2,100,000/2 =1050000

Revised ROI for fruits= (255000+132000)/(2550000+1050000)= 10.75%

Revised ROI for Flowers =(382500+132000)/(2250000+1050000)=15.59%

Residual income for fruits =(255000+132000)-((2550000+1050000)*8%)=$99000


Residual income for flowers =(382500+132000)-((2250000+1050000)*8%)=$202500 = $250500

3.

ROI for frutis is increasing after investment so manager of Fruit will support the investment.

ROI for frutis in decreasing after investment so manager of Flower will not support the investment.


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