Oakmont Company has two divisions, Household Appliances and Construction Equipment. The manager of the Household Appliances division is evaluated on the basis of return on investment (ROI). The manager of the Construction Equipment division is evaluated on the basis of residual income. The cost of capital has been 12% and the ROI has been 16% for the two divisions. Each manager is currently considering a project with a 14% rate of return. According to the current evaluation system for managers, which manager(s) would have incentive to undertake the project?
A) Both managers would have incentive to undertake the project.
B) Neither manager would have incentive to undertake the project.
C) The manager of the Household Appliances division would have incentive to undertake the project, while the manager of the Construction Equipment division would not have incentive to undertake the project.
D) The manager of the Construction Equipment division would have incentive to undertake the project, while the manager of the Household Appliances division would not have incentive to undertake the project.

Question

Quizplus · Accepted Answer

The manager of the Construction Equipment division, evaluated on residual income, would see a positive increase from a project with a 14% return, as it exceeds the cost of capital (12%). However, the Household Appliances division manager, evaluated on ROI, would see a decrease from the division's current 16% ROI, thus lacking incentive.

Oakmont Company Has Two Divisions, Household Appliances and Construction Equipment