ACCA MA · Chapter 14 · Question 3 of 11
A division currently earns an ROI of 20%, and the company's cost of capital is 12%. The divisional manager is offered a project with an expected ROI of 16%. If the manager is assessed on divisional ROI, which of the following is most likely?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: D) The manager will reject the project, even though it would increase residual income and benefit the company
Explanation
The project's 16% return is higher than the 12% cost of capital, so it gives a positive residual income and is good for the company. However, it would bring the division's ROI down from 20%, so a manager judged on ROI is likely to reject it. This kind of dysfunctional decision is a well-known weakness of ROI; RI avoids it.
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