Question 1 - CIMA CIMAPRO19-P02-1 Actual Real Exam Questions [Jan 2026 Update]

Q: 1

A company operates a divisional structure. The manager of division D receives a bonus based on the division's annual return on capital employed (ROCE). A minimum ROCE of 20% must be achieved to receive any bonus and thereafter the bonus increases in line with increases in ROCE. This year division D achieved a ROCE of 24% and the divisional manager received a large bonus. The manager is considering an investment in a new machine for next year. The incremental ROCE earned by the machine is expected to be 19% although the ROCE for the division as a whole with the machine is expected to be 22%. Without the machine, ROCE is likely to be stable at 24%. The cost of capital for the company as a whole is 18% per year. Which of the following statements is correct?

Options

Correct Answer:

Explanation

The manager's bonus is directly linked to the division's ROCE, increasing as the ROCE rises above the 20% threshold. Without the new investment, the division's ROCE is 24%. If the investment is accepted, the overall divisional ROCE will fall to 22%.

A rational manager, motivated by maximizing their personal bonus, will compare the outcome of 24% ROCE (no investment) with 22% ROCE (with investment). Since a higher ROCE leads to a larger bonus, the manager will reject the investment to maintain the 24% ROCE and secure a higher personal reward. This is a classic example of dysfunctional decision-making, where a performance measure incentivizes a manager to act against the company's best interests, as the project is profitable for the company (19% return > 18% cost of capital).

Why Incorrect

A. While the new ROCE of 22% exceeds the minimum target, it is lower than the 24% achievable without the investment, resulting in a smaller bonus.

C. This describes goal-congruent behavior from the company's perspective. However, the manager is evaluated and rewarded based on divisional ROCE, not on project-specific returns versus the cost of capital.

D. The new ROCE of 22% is above the 20% minimum threshold, so the manager would still receive a bonus, albeit a smaller one than without the investment.

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References

1. Drury

C. (2018). Management and Cost Accounting (10th ed.). Cengage Learning. In Chapter 18

Section 18.4

"Behavioural implications of using return on investment for performance evaluation

" it is explained that a major limitation of ROI (or ROCE) is that it can lead to dysfunctional decisions. Managers of highly profitable divisions may be reluctant to invest in new projects that are profitable for the company but would reduce the division's overall ROI. This directly supports the reasoning that the manager will reject the investment.

2. Bhimani

Horngren

C. T.

Datar

S. M.

& Rajan

M. V. (2012). Management and Cost Accounting (5th ed.). Pearson Education. Chapter 24

"Performance measurement

compensation and multinational considerations

" discusses the incentives for managers. It highlights that when performance is measured by ROI

managers may be induced to reject projects with an ROI lower than their current divisional average

even if the project's ROI exceeds the required rate of return for the company as a whole.

3. Kaplan

R. S.

& Atkinson

A. A. (1998). Advanced Management Accounting (3rd ed.). Prentice-Hall. Chapter 10

"Measuring the Performance of Investment Center Managers

" details the suboptimization problem with ROI. It states

"The ROI criterion may induce managers of highly profitable divisions to reject desirable projects... that would yield a return greater than the company's cost of capital but less than the division's current ROI" (p. 562). This perfectly describes the scenario in the question.

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