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ACCA Strategic Professional · Advanced Performance Management · Financial performance measurement

Kestrel Division has an ROI of 20% and capital employed of $5,000,000. The group's required return is 14%. The divisional manager, whose bonus is based on ROI, is offered a project costing $1,000,000 that will earn a return of 16% a year. Which statement best describes the likely outcome?

The manager will probably reject the project. Its 16% return is below the division's 20% ROI, so accepting it lowers divisional ROI to about 19.3%, even though it beats the 14% required return and adds value to the group. This shows a goal congruence weakness of ROI.

  1. AThe manager will accept it because it exceeds the group's required return and raises divisional ROI
  2. BThe manager will reject it because it lowers divisional ROI, even though it adds value to the groupCorrect
  3. CThe manager will reject it because it would reduce residual income
  4. DThe manager will accept it because its return is above the cost of capital and ROI is unaffected

Explanation

A 16% return is below the current 20% ROI, so it dilutes divisional ROI: (1,000,000 + 160,000) / 6,000,000 = 19.3%. However, 16% exceeds the 14% required return, so it would add residual income of 20,000 (160,000 - 140,000). The manager is therefore likely to reject a project that benefits the group, a dysfunctional lack of goal congruence.

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