ExpertMinds LogoExpertMinds
Medium2 marksMultiple Choice
Performance measurement and controlSyllabus EROIResidual IncomeDivisional Performance

ACCA · Question 05 · Performance measurement and control

Section A

MetroWater, a public utility company, evaluates its regional divisions using Return on Investment (ROI). The Northern Division currently has an ROI of 18%. The company's cost of capital is 12%. The Northern Division manager is considering a new water purification project that will yield an ROI of 15%.

How will the manager's decision regarding the new project differ if evaluated on ROI versus Residual Income (RI)?

Answer options:

A.

The manager will accept the project under both ROI and RI.

B.

The manager will reject the project under both ROI and RI.

C.

Under ROI, the manager will reject the project; under RI, the manager will accept it.

D.

Under ROI, the manager will accept the project; under RI, the manager will reject it.

How to approach this question

Compare the project's ROI to the division's current ROI (for the ROI decision) and to the cost of capital (for the RI decision).

Full Answer

C.Under ROI, the manager will reject the project; under RI, the manager will accept it.✓ Correct
If evaluated on ROI, the manager will reject the project because its 15% return is lower than the current 18%, which would dilute the division's overall ROI. If evaluated on RI, the project earns 15% against a cost of capital of 12%, generating positive residual income, so the manager would accept it. This is a classic example of ROI causing sub-optimal decision making.

Common mistakes

Assuming that because the project ROI (15%) is higher than the cost of capital (12%), the manager will automatically accept it under ROI.
04All questions06

Practice the full ACCA PM — Performance Management Practice Exam 2

32 questions · hints · full answers · grading

Sign up freeTake the exam

More questions from this exam

Q01**Section A** AgriData is a modern agricultural cooperative that uses drone imagery and soil sen...MediumQ02**Section A** NeuroTech is a startup developing a new brain-computer interface headset. The esti...EasyQ03**Section A** GlobalRelief, an NGO, distributes two types of emergency kits: Standard and Medica...MediumQ04**Section A** CloudServe, an IT consultancy firm, is considering abandoning traditional annual b...MediumQ06**Section A** FinTech Solutions has recently migrated its entire management accounting system to...Easy
View all 32 questions →