Question

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 $ 1,260,000 $ 1,890,000 Cost of goods sold and operating expenses 945,000 1,323,000 Net operating income $ 315,000 $ 567,000 Average invested assets $ 6,300,000 $ 2,362,500 Orange has established a hurdle rate of 4 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%.)) 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 $140,000. The total investment required is $2,000,000, 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%.)) 3. Which manager will accept the investment.

Answer 1

Answer to Part 1-a.

Return on Investment = Margin * Turnover
Margin = Net Operating Income / Sales * 100
Turnover = Sales / Average Invested Assets

Fruit Division:
Margin = 315,000 / 1,260,000 * 100
Margin = 25%

Turnover = 1,260,000 / 6,300,000
Turnover = 0.2

Return on Investment = 25 * 0.2
Return on Investment = 5%

Flower Division:
Margin = 567,000 / 1,890,000 * 100
Margin = 30%

Turnover = 1,890,000 / 2,362,500
Turnover = 0.8

Return on Investment = 30 * 0.8
Return on Investment = 24%

Answer to Part 1-b.

Flower Division Manager is performing better, as it has higher Return on Investment.

Answer to Part 2.

Return on Investment = Margin * Turnover
Margin = Net Operating Income / Sales * 100
Turnover = Sales / Average Invested Assets

Fruit Division:
Expected Net Operating Income = $315,000 + $140,000 = $455,000
Average Invested Assets = $6,300,000 + $1,000,000 = $7,300,000

Margin = 455,000 / 1,260,000 * 100
Margin = 36.11%

Turnover = 1,260,000 / 7,300,000
Turnover = 0.17

Return on Investment = 36.11 * 0.17
Return on Investment = 6.14%

Flower Division:
Expected Net Operating Income = $567,000 + $140,000 = $707,000
Average Invested Assets = $2,362,500 + $1,000,000 = $3,362,500

Margin = 707,000 / 1,890,000 * 100
Margin = 37.41%

Turnover = 1,890,000 / 3,362,500
Turnover = 0.56

Return on Investment = 37.41 * 0.56
Return on Investment = 20.95%

Fruit Division Manager will accept the investment, as it will increase Return on Investment.