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ACCA Strategic Professional · Advanced Performance Management · Financial performance measurement

Division Kestrel has capital employed of $5,000,000 and earns a ROI of 18%. Group cost of capital is 12%. Kestrel's manager can accept a project requiring $1,000,000 that earns $150,000 a year. Which statement is correct?

The manager will reject the project under ROI but it would raise residual income. The project returns 15%, below the division's 18% average ROI, yet above the 12% cost of capital, adding $30,000 of residual income. This shows ROI can cause goal incongruence.

  1. AThe manager will accept under ROI and the project also increases residual income, so goals are congruent
  2. BThe manager will reject under ROI, although the project would increase residual incomeCorrect
  3. CThe manager will accept under ROI, although the project would reduce residual income
  4. DThe manager will reject under ROI and the project would also reduce residual income

Explanation

Project return is 150,000/1,000,000 = 15%, below Kestrel's 18% average, so ROI would fall and the manager would reject. But 15% exceeds the 12% cost of capital: RI change = 150,000 - 120,000 = +$30,000. This is dysfunctional rejection of a value-adding project under ROI.

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