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ACCA Applied Knowledge · Management Accounting · Performance measurement - overview

Kestrel Co has a division with capital employed of $800,000 and profit of $136,000, giving ROI of 17%. The company's cost of capital is 12%. A new project costing $200,000 would earn $30,000 a year. Which statement is correct?

An ROI-assessed manager would reject because the project's 15% return is below the division's 17%, but residual income would rise by $6,000 (30,000 less a 24,000 capital charge). RI therefore supports accepting a project that beats the 12% cost of capital.

  1. AUnder ROI the manager would accept, and under RI the project would increase divisional RI by $6,000
  2. BUnder ROI the manager would reject, and under RI the project would increase divisional RI by $6,000Correct
  3. CUnder ROI the manager would reject, and under RI the project would reduce divisional RI by $6,000
  4. DUnder ROI the manager would accept, and under RI the project would reduce divisional RI by $24,000

Explanation

Project ROI = 30,000/200,000 = 15%, below the divisional 17%, so ROI would fall and the manager would reject. Project RI = 30,000 - 12% x 200,000 = 30,000 - 24,000 = 6,000 positive, so RI would rise. This shows RI is better aligned with company goals when the project return exceeds the cost of capital.

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