Orange Corp. has two divisions: Fruit and Flower. The following information for

Question

Orange Corp. has two divisions: Fruit and Flower. The following information for the past year is available for each division:

   

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%.))

       


   

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

Explanation / Answer

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%

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