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 | $660,000 | $990,000 | |||
Cost of goods sold and operating expenses | 495,000 | 742,500 | |||
Net operating income | $165,000 | $247,500 | |||
Average invested assets | $2,062,500 | $1,375,000 | |||
Orange has established a hurdle rate of 5 percent.
Required:
1. Compute each division’s return on investment
(ROI) and residual income for last year.
2. Suppose Orange is investing in new technology
that will increase each division’s operating income by $120,000.
The total investment required is $1,500,000, which will be split
evenly between the two divisions. Calculate the ROI and residual
income for each division after the investment is made. Enter ROI as
a percentage rounded to 2 decimal places.
1. Return on Investments = Net operating income / Average invested assets
Particulars | Fruit division | Flower division |
---|---|---|
1. Net income | $165,000 | $247,500 |
2. Average invested assets | $2,062,500 | $1,375,000 |
Return on investment ( 1/2 ) | 8% | 18% |
Residual income = Average invested assets * hurdle rate
Last year, Fruit division residual income = $2,062,500 * 5%
= $ 103,125
Last year, Flower division residual income = $1,375,000 * 5%
= $68,750
2. Orange is investing in new technology which increase each division's operating income by $120,000
Net operating income of Fruit division = $165,000 + $120,000 = $285,000
Net operating income of Flower division = $247,500 + $120,000 = $367,500
Total investment required is $1,500,000 and is evenly split between 2 divisions with $750,000 each.
Particulars | Fruit division | Flower division |
---|---|---|
1. Net operating income | $285,000 | $367,500 |
2. Average invested assets | $2,062,500 | $1,375,000 |
3. Additional investment | $750,000 | $750,000 |
4. Total investment ( 2 + 3) | $2,812,500 | $2,125,000 |
Return on investment (1/4) | 10.13% | 17.29% |
Residual income for fruit division = Total investment * hurdle rate = $2,812,500 * 13% = $365,625
Residual income for flower division = $2,125,000 * 13% = $276,250