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ACCA Applied Knowledge · Management Accounting · Performance measurement - application

Division M has operating profit of $300,000 and capital employed of $2,000,000, with a cost of capital of 10%. It is offered an investment of $400,000 earning $50,000 a year. Which statement is correct if the investment is accepted?

ROI falls from 15% to 14.58% while residual income rises by $10,000. New profit of $350,000 over capital of $2,400,000 gives 14.58%. The project earns 12.5%, above the 10% cost of capital, so residual income improves by $50,000 less a $40,000 charge.

  1. AROI falls from 15% to 14.58% and residual income increases by $10,000Correct
  2. BROI falls from 15% to 14.58% and residual income decreases by $10,000
  3. CROI rises from 15% to 15.5% and residual income increases by $10,000
  4. DROI falls from 15% to 14.58% and residual income increases by $50,000

Explanation

Current ROI = 300/2,000 = 15%. New ROI = 350,000/2,400,000 = 14.58%. The project's return of 12.5% is below 15%, so ROI falls. Residual income change = 50,000 - 10% x 400,000 = +10,000. The $50,000 option ignores the capital charge.

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