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 | $ | 1,740,000 | $ | 2,610,000 | |
Cost of goods sold and operating expenses | 1,392,000 | 1,957,500 | |||
Net operating income | $ | 348,000 | $ | 652,500 | |
Average invested assets | $ | 3,480,000 | $ | 2,718,750 | |
Orange has established a hurdle rate of 6
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%.))
2. Suppose Orange is investing in new technology
that will increase each division’s operating income by $131,000.
The total investment required is $2,200,000, 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%.))
1(a) Compute each division’s return on investment (ROI) and residual income for last year
ROI
Fruit Division
ROI = (Net Operating Income / Average Operating Assets ) x 100
= ($3,48,000 / $34,80,000 ) x 100
= 10%
Flower Division
ROI = (Net Operating Income / Average Operating Assets ) x 100
= ($652500 / $2718750) x 100
= 24%
Residual Income
Fruit Division
Residual Income=Net Operating Income - (Average operating assets x Hurdle rate)
= $3,48,000 – ($3480000 x 6%)
= $3,48,000 – $208800
= $1,39,200
Flower Division
Residual Income=Net Operating Income - (Average operating assets x Hurdle rate)
= $652500 - ($2718750 x 6%)
= $652500 - $ 163125
= $ 4,89,375
2. Suppose Orange is investing in new technology that will increase each division’s operating income by $131,000. The total investment required is $2,200,000, which will be split evenly between the two divisions. Calculate the ROI and return on investment for each division after the investment is made.
New Operating Income
Fruit Division = $348000 - $131000 = $217000
Flower Division = $652500 - $131000 = $521500
New Average Investment
Fruit Division = $3480000 + $1100000 = $4580000
Flower Division = $2718750 + $1100000 = $ 3818750
Fruit Division
ROI = (Net Operating Income / Average Operating Assets ) x 100
= ($217000 / $4580000) x 100
= 4.74%
Flower Division
ROI = (Net Operating Income / Average Operating Assets ) x 100
= ($521500 / 3818750) x 100
= 13.66%