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CMA Intermediate · Management Accounting · Responsibility Accounting

Division X of Sagar Foods has ROI of 22% and a manager is considering a project with ROI of 18%. The company's cost of capital is 14%. If the manager is judged on ROI, and the company wants to maximise value, which statement is correct?

The manager would reject the project under ROI because 18 percent dilutes the existing 22 percent, but the company should accept it because 18 percent exceeds the 14 percent cost of capital. This shows ROI can cause dysfunctional, sub-optimal decisions.

  1. AManager accepts it under ROI; company should reject it
  2. BManager rejects it under ROI, though company should accept it as 18% exceeds 14%Correct
  3. CBoth manager and company should reject it
  4. DBoth manager and company should accept it, since ROI rises

Explanation

Adding a project at 18% lowers the divisional average of 22%, so an ROI-judged manager rejects it. Since 18% exceeds the 14% cost of capital, it adds residual income and value, so the company should accept. This is the goal-incongruence weakness of ROI.

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