US CMA Part 1 · Chapter 3 · Question 23 of 30
A division currently earns an ROI of 18%. Its manager is considering a project expected to earn 15% on its investment. The company's cost of capital is 12%. If the manager is evaluated on ROI, what is the likely outcome?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: D) The manager will probably reject the project, although it would increase the division's residual income
Explanation
Adding a 15% project to an 18% division lowers average ROI, so an ROI-evaluated manager is tempted to reject it. Because 15% exceeds the 12% cost of capital, the project has positive residual income and adds value, so rejecting it is not goal congruent. This is a key weakness of ROI compared with residual income.
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