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ACCA Applied Knowledge · Management Accounting · Performance measurement - application

Division R earns ROI of 20% on capital employed of $500,000. The cost of capital is 12%. A new project costing $100,000 would earn annual profit of $15,000. Which statement is correct?

The project earns 15%, lower than the division's 20% ROI, so an ROI-driven manager would reject it. However it exceeds the 12% cost of capital, adding $3,000 of residual income, so an RI-driven manager would accept it. This shows goal congruence differences.

  1. AThe manager using ROI would reject the project but the manager using RI would accept itCorrect
  2. BBoth ROI and RI would lead to acceptance
  3. CBoth ROI and RI would lead to rejection
  4. DThe manager using ROI would accept it but RI would reject it

Explanation

The project's return is 15%, below the existing 20%, so ROI would fall and the project be rejected. Its return exceeds the 12% cost of capital: RI change = 15,000 - 12,000 = +3,000, so RI favours acceptance. This shows how ROI can cause dysfunctional decisions.

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