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CA Final · Integrated Business Solutions (Multidisciplinary Case Study with Strategic Management) · Strategic Cost & Performance Management

Case: Sundaram Auto Components Ltd's division earns Rs 90 lakh on capital employed of Rs 600 lakh (ROI 15%), with a cost of capital of 12%. A new project requires Rs 100 lakh investment and yields Rs 13 lakh annually. The manager is judged on ROI, while the company wants to maximise shareholder value. What is the likely outcome?

The manager will reject it. Project return of 13% is below the divisional ROI of 15%, so divisional ROI would fall to about 14.7%, even though the project beats the 12% cost of capital and adds Rs 1 lakh of residual income. This shows ROI's goal incongruence.

  1. AManager rejects the project because the project ROI of 13% lowers divisional ROI, though it exceeds the 12% cost of capitalCorrect
  2. BManager accepts the project because 13% is above 12% and ROI rises
  3. CManager rejects the project because its Residual Income is negative
  4. DManager is indifferent because divisional ROI stays at 15%

Explanation

Project ROI = 13/100 = 13%, below the divisional 15%, so divisional ROI falls to 103/700 = 14.7%. Project RI = 13 - 12 = Rs 1 lakh, positive, so it adds value. This is the goal incongruence problem of ROI.

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