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   $   1,740,000      $   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 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 residual income for each division after the investment is made. 3. Determine whether both managers will support the investment.

Answer 1

Solution:

Computation of ROI
	Fruit division	Flower division
Operating Income	$348,000	$652,500
/Average Invested assets	$3,480,000	$2,718,750
ROI	10.00%	24.00%

Computation of ROI (After investment is made)
	Fruit division	Flower division
Operating Income	$479,000	$783,500
/Average Invested assets	$4,580,000	$3,818,750
ROI	10.46%	20.52%

Fruit division will support the investment as its ROI is increasing.

Note: Residual income cannot be calculated as Hurdle rate is not available.