Two divisions: ROI, residual income and the choice of measures

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• Division A ROI = 900 / 6,000 = 15.0%.
• Division B ROI = 400 / 2,000 = 20.0%.
• Division A residual income = 900 - 12% x 6,000 = $180k.
• Division B residual income = 400 - 12% x 2,000 = $160k.
• On ROI, B ranks higher, but on residual income A creates more absolute value, so the rankings differ because ROI ignores scale.
• Both divisions earn more than the cost of capital and are creating value.

Marks counted: 0 of 6

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• The project earns 170 / 1,000 = 17%, which is above the group cost of capital of 12%, so it should be accepted by the group.
• Division A new ROI = (900 + 170) / (6,000 + 1,000) = 15.3%, which is an increase from 15.0%, so A's manager will accept.
• Division B new ROI = (400 + 170) / (2,000 + 1,000) = 19.0%, which is a fall from 20.0%, so B's manager is likely to reject.
• Residual income rises by 170 - 12% x 1,000 = $50k in both divisions.
• This is an example of dysfunctional behaviour or a lack of goal congruence, because B rejects a project that creates value for the group.
• Residual income or EVA would encourage acceptance, as any project earning more than the cost of capital improves it.
• Residual income depends on the choice of cost of capital and is an absolute measure, so it is harder to compare across divisions of different sizes.
• The effect of other issues: depreciation, valuation of capital employed and short-term focus.

Marks counted: 0 of 8

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• Use residual income or EVA as the main financial measure of divisions, with ROI as a supporting measure.
• Add non-financial measures from a balanced scorecard: customer satisfaction, process quality and employee development.
• Link the measures to the strategy through critical success factors and targets.
• Consider controllability, so that managers are judged on items that they influence.
• Balance short-term and long-term measures, for example with investment in training and innovation.
• Be aware of the costs of the new system and how staff will respond, and phase in the changes.

Marks counted: 0 of 6

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• Managers have an interest in the results, which gives rise to optimism or bias.
• Challenge assumptions about sales, costs and the life of the project.
• Compare with past forecasts and with external benchmarks.
• Ask for evidence and consider the downside scenario.
• Review of a forecast by someone independent of the division.

Marks counted: 0 of 5