In: Accounting
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.
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.