A Limited has two divisions, with the following information:

Division A () Division B ()

Profit 60,000 12,000

Capital employed 240,000 120,000

Return on investment (ROI) 25% 10%

Division A has been offered a project costing 80,000 and giving annual returns of 15,000. Division B has been offered a project costing 100,000 and giving annual returns of 12,500. The companys cost of capital is 16%. Divisional performance is judged on ROI and the ROI related bonus is sufficiently high to influence the managers behaviour.

You are required to:

a). Calculate the ROI for each division, including the projects offered. What decisions will be made by managers as regards the projects offered if they act in the best interests of their division (and of their bonus)? Explain your reasoning. (10 marks)

b). What decision should the managers make if they act in the best interest of the company? Again, explain your reasoning. (5 marks)

c). Summarise the advantages and disadvantages of using ROI as a measure of divisional performance. (5 marks)

Total (20 marks)