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ACCA Applied Knowledge · Management Accounting · Performance measurement - application

Division X has operating profit of $240,000 and capital employed of $1,200,000. The company's cost of capital is 15%. A new project would cost $200,000 and earn an annual profit of $34,000. Which statement about the divisional manager's likely decision, if assessed on ROI, is correct?

The manager would reject the project. Its return of 17% is below the division's current ROI of 20%, so divisional ROI would fall, even though 17% exceeds the 15% cost of capital and the project would add value for the company. This shows ROI can cause goal incongruence.

  1. AThe manager would accept the project because its return of 17% exceeds the current ROI of 20%
  2. BThe manager would reject the project because its return of 17% is below the current ROI of 20%, even though it exceeds the cost of capitalCorrect
  3. CThe manager would accept the project because its return of 17% exceeds the cost of capital of 15%, and ROI would rise
  4. DThe manager would reject the project because its return of 17% is below the cost of capital of 15%

Explanation

Current ROI = 240,000/1,200,000 = 20%. Project return = 34,000/200,000 = 17%, which is below 20% so divisional ROI would fall, so the manager rejects it. However 17% exceeds the 15% cost of capital, so the company would benefit; this is a goal incongruence problem with ROI. Residual income would be positive: 34,000 - 30,000 = 4,000.

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