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ACCA Applied Skills · Performance Management · Performance analysis

Division Q has operating profit of $270,000 and capital employed of $1,500,000. Its manager is considering a project that costs $200,000 and earns a profit of $32,000 a year. The group's required return is 14%. Which statement is correct?

The manager would reject the project under ROI but residual income favours acceptance. The project earns 16%, below the division's current 18% ROI, so ROI would fall. However, 16% exceeds the 14% required return, giving positive residual income of $4,000 ($32,000 less $28,000 capital charge).

  1. AThe manager would accept under ROI but the group would want it rejected under residual income
  2. BThe manager would reject under ROI but the group would want it accepted under residual incomeCorrect
  3. CBoth ROI and residual income support acceptance
  4. DBoth ROI and residual income support rejection

Explanation

Current ROI = 270,000/1,500,000 = 18%. The project's return = 32,000/200,000 = 16%, which lowers divisional ROI, so a manager judged on ROI would reject. Residual income from the project = 32,000 - (14% x 200,000 = 28,000) = +4,000, so it adds value and should be accepted. Option A has the reverse effect.

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