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CMA Final · Strategic Performance Management and Business Valuation · Performance Measurement, Evaluation and Improvement Tools

Kaveri Foods Ltd has a division with operating profit of ₹48 lakh and divisional investment of ₹300 lakh. The company's required rate of return is 12%. A new project costing ₹50 lakh would earn ₹7 lakh a year. Comparing the decision under ROI and Residual Income (RI) for the divisional manager, which statement is correct?

The project would be rejected under ROI and accepted under residual income. Its 14 percent return is below the division's current 16 percent ROI, so divisional ROI would fall, but it exceeds the 12 percent required return, giving a positive residual income of ₹1 lakh.

  1. AAccept under ROI and reject under RI
  2. BReject under ROI and accept under RICorrect
  3. CAccept under both ROI and RI
  4. DReject under both ROI and RI

Explanation

Current ROI = 48/300 = 16%. Project return = 7/50 = 14%, which is below 16%, so ROI would fall (new ROI = 55/350 = 15.7%) and the manager rejects. Project RI = 7 − 12% × 50 = 7 − 6 = ₹1 lakh, which is positive, so RI favours acceptance. The sign of the RI is positive because 14% exceeds 12%.

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