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 $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.

Solutions

Expert Solution

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


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