A division earns an ROI of 22% and the group requires 15%. A new project would earn 18% on its investment. Which statement is correct?
Answer and explanation
Correct answer: D. The manager might reject it because it lowers divisional ROI, though it exceeds the 15% required return
- Step 1: Divisional ROI is 22%; a project earning 18% would lower the average.
- Step 2: A manager judged by ROI may reject it even though it earns more than the 15% group cost of capital.
- Step 3: Residual income avoids this problem by rewarding any project that earns more than the cost of capital.
Answer
The manager might reject it because it lowers divisional ROI, though it exceeds the 15% required return.
Why not the others: The project's 18% is below the division's current ROI of 22%, so accepting it would lower divisional ROI. 18% is above the 15% required return, so it is acceptable to the group. ROI is a commonly used divisional measure and can influence decisions.
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