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	$	840,000		$	1,260,000
Cost of goods sold and operating expenses		630,000			945,000
Net operating income	$	210,000		$	315,000
Average invested assets	$	2,100,000		$	1,750,000

Orange has established a hurdle rate of 6 percent.   

2. Suppose Orange is investing in new technology that will increase each division’s operating income by $126,000. The total investment required is $1,800,000, 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%.))

          

Answer 1

	Fruit Division	Flower Division
Net operating income	210,000	315,000
Increase in Net operating income	126,000	126,000
Net operating income after the investment is made	336,000	441,000
Average invested assets	2,100,000	1,750,000
Increase in investment	900,000	900,000
Average invested assets after the investment is made	3,000,000	2,650,000
ROI ( after the investment is made ) = Net operating income/Average invested assets	336,000/3,000,000 = 11.2%	441,000/2,650,000 = 16.64%
Residual income = Net operating income - (Average invested assets x Hurdle rate)	336,000 - (3,000,000 x 6%) = $156,000	441,000 - (2,650,000 x 6%) = $282,000