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CMA Intermediate · Management Accounting · Divisional Performance Measurement

Division C of Narmada Foods has capital employed of ₹80,00,000 and ROI of 22%. The company's cost of capital is 16%. A new project costing ₹20,00,000 will yield annual profit of ₹3,60,000. Divisional performance is judged on ROI, while the company wants to maximise value. Which statement is correct?

The project is rejected under ROI but desirable under RI. Its return of 18 percent is below the division's existing 22 percent, lowering ROI, yet it exceeds the 16 percent cost of capital, giving positive residual income of ₹40,000. ROI therefore can discourage value-adding investment.

  1. AAccept the project under both ROI and RI criteria
  2. BReject under ROI but it is desirable under RICorrect
  3. CReject under both ROI and RI criteria
  4. DAccept under ROI but it is undesirable under RI

Explanation

Project return = 3,60,000 / 20,00,000 = 18%, below the division's 22%, so ROI would fall and a ROI-judged manager rejects it. Against the 16% cost of capital, RI = 3,60,000 − 3,20,000 = ₹40,000, positive, so it adds value. This is the goal-incongruence problem of ROI.

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