Cost Accounting Quiz: Budget Gaming And Cost Distortion

20 questions · exam conditions

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Budget Gaming And Cost DistortionQuestion 1 of 20

A defense contractor works on both cost-reimbursement government contracts and fixed-price commercial contracts. The government contracts have strict rules on 'allowable' costs that can be reimbursed. The company's accounting system allows for some discretion in how certain shared, indirect costs (e.g., corporate legal services, general R&D) are allocated to specific contracts. What incentive does this contract mix create for the company's cost allocation choices?

To develop allocation methods that assign a disproportionately large share of ambiguous indirect costs to the cost-reimbursement contracts.

To minimize the amount of indirect costs allocated to any contract to make the company's pricing appear more competitive.

To allocate indirect costs based on a cause-and-effect relationship to ensure fairness to all clients and compliance with regulations.

To create a single, simple overhead rate to be applied uniformly across both government and commercial contracts to ensure consistency.

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Cost Accounting Quiz

Cost Accounting Quiz: Budget Gaming And Cost Distortion

Practice Budget Gaming And Cost Distortion in Cost Accounting with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Budget Gaming And Cost Distortion, giving you a quick way to practice the rules, question types, and explanations that matter most for Cost Accounting.

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Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

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Question 1

To develop allocation methods that assign a disproportionately large share of ambiguous indirect costs to the cost-reimbursement contracts. (correct answer)
To minimize the amount of indirect costs allocated to any contract to make the company's pricing appear more competitive.
To allocate indirect costs based on a cause-and-effect relationship to ensure fairness to all clients and compliance with regulations.
To create a single, simple overhead rate to be applied uniformly across both government and commercial contracts to ensure consistency.

Explanation: The correct answer is C. The company has a strong incentive to maximize its reimbursement from the government contracts. Since these contracts reimburse allowable costs, the company is motivated to classify as many costs as possible as direct costs to those contracts and to choose allocation bases that shift a larger portion of shared indirect costs to them. This distorts the true cost of both types of contracts, effectively subsidizing the fixed-price commercial work with the cost-reimbursement government work. A describes best practice, not the gaming incentive. B is counter-productive for the cost-reimbursement contracts. D would prevent the company from capitalizing on the incentive to shift costs to the government work.

Question 2

A manufacturing company's budgeting process incorporates a 'ratchet effect,' where the current year's actual performance becomes the primary basis for setting the following year's budget targets. A department manager who successfully reduces costs by 15% in the current year, exceeding their target of 5%, will likely face a significantly more challenging cost reduction target next year. Which of the following behaviors is most strongly incentivized by this budgeting practice?

Maximizing reported performance in the current period to secure a larger bonus, regardless of future budget implications.
Engaging in 'use it or lose it' spending at year-end to ensure the department's budget is not reduced in the subsequent period.
Intentionally managing performance to meet but not substantially exceed the current budget target to avoid unachievable targets in the future. (correct answer)
Shifting costs to other departments with less stringent budget oversight to improve the manager's own departmental results.

Explanation: The correct answer is C. The ratchet effect creates a perverse incentive for managers to hold back effort or performance. If they perform too well, their future targets will be raised to a level that may be difficult or impossible to achieve. Therefore, managers are incentivized to create budgetary slack or manage performance to meet the current target without significantly exceeding it, making future targets more manageable. A is incorrect because the long-term negative effect of a much higher future target may outweigh the short-term benefit of a larger bonus. B describes a different type of gaming, typically found where budgets are based on prior spending levels, not performance against a target. D describes cost distortion, but it is not the primary behavior incentivized by the ratchet effect itself.

Question 3

A government agency's funding for the next fiscal year is determined primarily by its expenditure rate in the current year. Unspent funds at the end of the year are returned to the central treasury and may result in a lower appropriation for the following year. With one month left in the fiscal year, the agency director notes that they are 15% under budget. Which behavior is most likely to be incentivized by this funding mechanism?

Returning the surplus funds to demonstrate fiscal responsibility and efficient management of taxpayer money.
Accelerating expenditures on non-essential equipment and discretionary training programs before the fiscal year-end. (correct answer)
Postponing necessary maintenance projects into the next fiscal year to create a larger budget surplus.
Requesting a mid-year budget reduction to align the agency's appropriation with its actual needs.

Explanation: The correct answer is B. This is a classic example of the 'use it or lose it' incentive. To avoid having their budget cut in the following year, the agency director is incentivized to spend the remaining funds, often on items that are not of the highest priority. This ensures that the agency's expenditure level remains high, justifying a similar level of funding in the future. A, C, and D all describe actions that would likely lead to a budget cut under this system, which is precisely the outcome the director is incentivized to avoid.

Question 4

A division manager's performance is heavily weighted on meeting a quarterly profit target. As the end of the quarter approaches, the division is projected to fall slightly short of this target. The manager is considering several actions to close the gap. Which of the following actions represents a form of budget gaming related to cost distortion rather than timing?

Offering generous sales terms to customers to pull sales from the next quarter into the current one.
Delaying a non-critical, discretionary employee training program until the start of the next quarter.
Pressuring the accounting department to reclassify certain period costs, like administrative salaries, as inventoriable product costs. (correct answer)
Postponing routine factory maintenance that was scheduled for the last week of the quarter.

Explanation: The correct answer is C. This action distorts the reported costs for the period. By capitalizing costs that should be expensed (period costs), the manager reduces the current period's expenses and increases inventory on the balance sheet, thereby inflating profit. This is a cost distortion. A, B, and D are all examples of timing games—actions that shift revenues or expenses between periods but do not fundamentally misrepresent the nature of the costs themselves. A is accelerating revenue, while B and D are deferring expenses.

Question 5

A company's purchasing manager is evaluated on achieving favorable purchase price variances, while the production manager is evaluated on achieving favorable material quantity (efficiency) variances. The purchasing manager secures a large volume of raw materials at a price significantly below standard, creating a large favorable price variance. However, these materials are of a lower quality than usual. What is the most likely incentive for the production manager regarding these materials?

To use the materials quickly to help the purchasing manager realize their favorable price variance.
To formally reject the materials, arguing that their use will lead to excessive waste and rework, creating an unfavorable quantity variance. (correct answer)
To mix the low-quality materials with high-quality stock to mask any potential production problems and avoid conflict.
To request a temporary revision of the material quantity standard to account for the lower quality of the input.

Explanation: The correct answer is B. The conflicting performance metrics create goal incongruence between the departments. While the purchasing manager is rewarded for buying cheap materials, the production manager knows that low-quality inputs are likely to cause production problems, increase scrap and waste, and require more material to produce a finished good. This would result in an unfavorable material quantity variance, negatively impacting the production manager's evaluation. Therefore, the production manager is incentivized to reject the materials to protect their own performance metrics. A, C, and D all represent ways of accommodating the poor materials, which runs counter to the production manager's direct incentive.

Question 6

A construction firm has historically worked on 'cost-plus' contracts, where the client pays for all incurred costs plus a fixed percentage profit. The firm is now bidding for a large 'fixed-price' contract, where it will be paid a single, predetermined amount for the entire project. How does this shift in contract type alter the project manager's incentives regarding cost management and reporting?

It creates a stronger incentive to accurately trace and document all costs to ensure full reimbursement from the client.
It creates an incentive to substitute lower-quality materials and reduce discretionary spending to maximize the project's profit margin. (correct answer)
It reduces the incentive for cost control, as the price is already locked in and cannot be changed by the client.
It creates an incentive to allocate as much corporate overhead as possible to the project to absorb fixed costs.

Explanation: The correct answer is B. Under a cost-plus contract, there is little incentive to control costs, and there may even be an incentive to inflate them to increase the total profit (which is a percentage of cost). Under a fixed-price contract, the revenue is fixed. Therefore, profit is maximized by minimizing costs. This creates a powerful incentive for the project manager to aggressively control all project costs, which may include making trade-offs like using less expensive materials or cutting back on non-essential activities. A describes the incentive under cost-plus. C is incorrect; the incentive for cost control is maximized, not reduced. D describes an incentive that exists under cost-plus (to maximize reimbursement) but is detrimental under fixed-price, as every dollar of cost reduces profit by a dollar.

Question 7

A decentralized company evaluates its investment center managers primarily based on Residual Income (RI), calculated as Operating Income - (Required Rate of Return × Average Operating Assets). How does the use of RI, as opposed to Return on Investment (ROI), affect a manager's incentive to accept a profitable investment opportunity?

RI provides the same investment incentive as ROI, as both metrics are based on operating income and assets.
RI may discourage investment in projects with an ROI greater than the required rate of return but less than the division's current ROI.
RI encourages investment in any project that is expected to earn a return greater than the company's required rate of return. (correct answer)
RI encourages managers to minimize their asset base, even if it means rejecting profitable projects, to reduce the capital charge.

Explanation: The correct answer is C. The primary advantage of Residual Income over ROI is that it promotes goal congruence for investment decisions. As long as a project's expected ROI is greater than the required rate of return (the capital charge percentage), it will generate a positive RI and increase the division's total RI. Therefore, the manager is incentivized to accept all projects that are profitable from the company's perspective. B describes the dysfunctional incentive created by ROI, which RI is designed to prevent. A is incorrect because they create different incentives. D is a misinterpretation; while minimizing the asset base is part of managing RI, rejecting a project with a positive RI would decrease the manager's performance, so this is not incentivized.

Question 8

The sales team at a software company has a quarterly commission plan where the commission rate is 5% on sales up to $1 million, and jumps to 10% on all sales if the $1 million threshold is met. With one week left in the quarter, the team's sales are $950,000. Which behavior is most strongly incentivized by this commission structure?

Pushing borderline deals into the next quarter to ensure a strong start to the new period.
Requesting a transfer of sales credit from a different region to help them cross the threshold.
Focusing exclusively on high-margin products to increase the profitability of the sales already made.
Offering significant, short-term price discounts to close at least $50,000 in additional sales before the quarter ends. (correct answer)

Explanation: The correct answer is B. The tiered, retrospective commission structure creates a powerful incentive to cross the threshold. By reaching $1 million, the team's total commission would jump from $47,500 (5% of $950k) to at least $100,000 (10% of $1M). This large potential gain makes it rational to offer deep discounts or other concessions to 'pull forward' sales and ensure the target is met. A is what the team would do if they were far from the target. C is irrelevant as the commission is based on sales revenue, not margin. D is a form of cheating, whereas B is a form of gaming directly incentivized by the plan's structure.

Question 9

A company uses a standard costing system and evaluates production supervisors primarily on the labor efficiency variance. The supervisor can assign production runs to either a group of highly experienced, high-wage workers or a group of new, low-wage trainees. The labor efficiency standard was set based on the expected performance of an average, moderately experienced worker. To best improve their performance evaluation, the supervisor is incentivized to use which group of workers for a complex production run?

The trainees, because their low wage rate will generate a favorable labor rate variance that may offset any inefficiency.
The group whose average wage is closest to the standard rate to minimize the total labor variance.
A mix of both groups of workers to balance the trade-off between the labor rate and labor efficiency variances.
The experienced workers, because they are likely to complete the job much faster than the standard time, creating a large favorable efficiency variance. (correct answer)

Explanation: The correct answer is B. Since the supervisor is evaluated primarily on the labor efficiency variance, their incentive is to minimize the actual hours worked relative to the standard hours allowed. The highly experienced workers are most likely to achieve this, completing the job in less time and generating a favorable efficiency variance. While this will likely create an unfavorable labor rate variance (as their wages are higher than standard), this is not the primary evaluation metric. A is incorrect because the trainees are likely to be inefficient, leading to an unfavorable efficiency variance, which is the key metric for the supervisor. C and D describe attempts to manage the total variance, but the question specifies the supervisor's evaluation is based primarily on the efficiency variance.

Question 10

In a decentralized firm, the Electronics Division produces a component that is transferred to the Appliance Division. Company policy mandates that all internal transfers be priced at full absorption cost. The manager of the Electronics Division is evaluated based on the division's operating income. Which of the following provides the strongest incentive for cost distortion by the manager of the Electronics Division?

The desire to help the Appliance Division control its costs and improve overall corporate profitability.
The ability to negotiate a market-based transfer price with the Appliance Division if costs are too high.
The pressure to reduce inventory levels within the Electronics Division to lower holding costs.
The opportunity to classify factory administrative salaries, which are period costs, as part of manufacturing overhead. (correct answer)

Explanation: The correct answer is B. Since the transfer price is set at full absorption cost, the Electronics Division manager's revenue from the transfer is equal to the cost assigned to the product. To increase the division's operating income, the manager is incentivized to inflate this cost. One way to do this is by misclassifying period costs (which should be expensed immediately) as product costs (which are included in the full absorption cost). This inflates the transfer price, boosting the Electronics Division's revenue and profit at the direct expense of the Appliance Division. A represents goal congruence, the opposite of the incentive. C is a general management goal but doesn't relate directly to distorting the transfer price. D is not possible, as the question states the policy is mandated.

Question 11

A company uses a highly participative budgeting process where department managers submit initial expense budget proposals. However, senior management has a consistent history of implementing a uniform, across-the-board 5% cut to all initial proposals, regardless of individual justifications. This practice is widely known among managers. What is the primary incentive this process creates for department managers when preparing their initial budget submissions?

To intentionally inflate their initial budget request by at least 5% to protect their necessary funding from the anticipated cut. (correct answer)
To collaborate with other managers to present a unified front against the arbitrary budget cuts.
To submit a lean, realistic budget that accurately reflects the department's minimum resource needs.
To understate their expected expenses in the hope of appearing efficient and avoiding scrutiny from senior management.

Explanation: The correct answer is C. When managers know that their budget will be cut by a certain percentage regardless of their justification, they are incentivized to game the system by building that cut into their initial request. To receive the amount of funding they actually need, they will pad their request by 5% (or more), fully expecting it to be reduced. This directly leads to the creation of budgetary slack and makes the entire participative process a ritualized game rather than a genuine planning exercise. A and D would result in the manager's department being underfunded. B is a political action, not a direct incentive within the budgeting process itself.

Question 12

A company allocates all manufacturing overhead to products using a single, plant-wide rate based on direct labor hours. The manager of Department A, a highly automated department with low direct labor usage, is evaluated based on the reported full cost per unit of the products made in the department. The manager of Department B, a labor-intensive assembly department, is evaluated similarly. This costing system tends to over-cost products from Department A and under-cost products from Department B. What incentive does this cost distortion create for the manager of Department A?

To increase the automation level in the department further to reduce the allocation base of direct labor hours. (correct answer)
To shift the production of high-volume, simple products to their department while pushing complex products to Department B.
To argue for the implementation of an activity-based costing system to more accurately trace costs to products.
To increase the number of direct labor employees in order to absorb a larger, more proportionate share of the plant-wide overhead.

Explanation: The correct answer is A. Since overhead is allocated based on direct labor hours, a manager evaluated on full product cost is incentivized to reduce the allocation base within their control. By increasing automation and further reducing direct labor hours, the manager can decrease the amount of overhead allocated to their department, thereby lowering the reported cost per unit, even if the department's actual consumption of overhead resources (e.g., machine depreciation, power) increases. B is incorrect; the manager would prefer simple, high-volume products, but the incentive is to reduce the allocation base, not just shift product mix. C is a rational response to the problem but is not a form of gaming the existing system. D is the opposite of the manager's incentive; it would increase the allocated overhead and hurt their performance measure.

Question 13

A company allocates its corporate information technology (IT) costs to its operating divisions based on the number of employees in each division. The manager of a highly profitable services division, which has a large number of employees, is evaluated based on the division's net operating profit after all cost allocations. Which of the following strategic decisions is most likely to be incentivized by this allocation method?

Hiring additional employees to support growth, as long as their marginal revenue product exceeds their salary.
Investing heavily in IT training for all employees to maximize the value received from the allocated costs.
Aggressively pursuing outsourcing and automation to reduce headcount, even if the direct costs are slightly higher than hiring. (correct answer)
Splitting the division into two smaller divisions to dilute the impact of the cost allocation across more units.

Explanation: The correct answer is C. The cost allocation method creates an incentive for the divisional manager to reduce the allocation base, which in this case is the number of employees. By reducing headcount through outsourcing or automation, the manager can lower the amount of corporate IT cost allocated to their division. This will increase the division's reported net operating profit, even if the direct cost of the outsourcing or automation is not as efficient as hiring an employee. The manager is making a decision that improves their reported performance but may not be in the best economic interest of the company as a whole. A describes a rational economic decision that ignores the dysfunctional incentive of the allocation system. B is a reasonable action but doesn't address the core incentive. D is an organizational change, not a direct operational decision incentivized by the allocation method.

Question 14

A company implements an activity-based costing (ABC) system. One of the primary activities in the manufacturing support cost pool is 'production scheduling,' and its cost driver is the number of production runs. A product manager, responsible for a line of highly customized, low-volume products, is evaluated based on the product line's profitability as reported by the ABC system. What behavior is this product manager incentivized to exhibit?

Requesting more frequent, smaller production runs to reduce inventory holding costs and improve responsiveness to customer orders.
Focusing marketing efforts on increasing the sales volume of the customized products to spread the allocated costs over more units.
Challenging the accuracy of the cost driver, arguing that production scheduling costs are fixed and should not be allocated.
Lobbying the production department to consolidate orders into fewer, much larger production runs for the product line. (correct answer)

Explanation: The correct answer is B. Under the ABC system, a significant portion of manufacturing support cost is allocated to the product line based on the number of production runs. To improve the reported profitability of their product line, the manager is incentivized to reduce the consumption of this cost driver. Consolidating orders into fewer, larger production runs will directly achieve this, lowering the allocated cost and boosting reported profit. This action might, however, be suboptimal for the company if it leads to excessive inventory or slower customer response times. A is the opposite of the incentive. C and D are plausible actions but are not as direct a form of gaming the system as B.

Question 15

The research and development (R&D) department's annual budget is set as a fixed percentage of the company's total projected sales revenue for the upcoming year. This sales projection is developed through a collaborative process involving sales, marketing, and R&D managers. The company is anticipating a potential economic downturn. What incentive does this budgeting mechanism create for the R&D manager during the sales forecasting process?

To provide a highly conservative and pessimistic sales forecast to reduce performance pressure on the R&D department.
To remain neutral and objective in the forecasting process, as their budget is determined by factors outside their control.
To advocate for an optimistic sales forecast, even if it is unlikely, to protect the R&D budget from significant cuts. (correct answer)
To lobby for a change in the budgeting mechanism to one based on specific project needs rather than company-wide sales.

Explanation: The correct answer is C. Since the R&D budget is a direct function of projected sales, the R&D manager has a vested interest in that forecast being as high as possible. A high sales forecast will lead to a larger R&D budget. Therefore, the manager is incentivized to be overly optimistic and argue for higher sales numbers to protect their department's funding, even if those numbers are not realistic. This is a form of gaming the budget input process. A is the opposite of the incentive. B is unlikely, given the direct impact on the manager's resources. D is a strategic response to the system, not a way of gaming the existing system.

Question 16

The compensation plan for division managers at a company includes a bonus that is 10% of divisional profit exceeding a target of $5 million. The total bonus is capped at $200,000 for the year. The manager of the West Division has already achieved divisional profit of $7.5 million by October 31, thus reaching the maximum possible bonus ($ 200,000 = 10% * ($7,000,000 - $5,000,000)).

With two months remaining in the fiscal year and the maximum bonus already secured, which action is the manager of the West Division most incentivized to take?

Aggressively discount products to pull sales from the next fiscal year into the current year to maximize reported profit.
Delay the recognition of certain revenues into the next fiscal year to help ensure the achievement of next year's bonus. (correct answer)
Undertake a significant, discretionary advertising campaign in the last two months to build market share for the future.
Continue operations as normal, focusing on maximizing profit in the current period without regard for the bonus structure.

Explanation: The correct answer is B. Since the manager has already reached the bonus cap, there is no personal financial incentive to increase the current year's profit further. The manager is now incentivized to engage in a form of earnings management by shifting profits to the next period. Delaying revenue recognition makes it easier to meet or exceed the profit target in the following year, thus securing a future bonus. A is incorrect because there is no incentive to maximize current year profit further. C and D are related; undertaking an advertising campaign (C) would reduce current profit, which aligns with the incentive to shift profit, but delaying revenue (B) is a more direct way to manage reported earnings for future bonus attainment. While C is plausible, B is the most direct form of gaming incentivized by the situation.

Question 17

The manager of a software development team is evaluated based on completing projects within the budgeted timeline. The final, most time-consuming phase of a major project is 'Quality Assurance (QA) Testing.' The manager has discretion over how to define a 'completed' project for reporting purposes. The project is nearing its deadline but is behind schedule, and thorough QA testing has not been finished. What incentive does the performance metric create in this situation?

To request a formal extension of the deadline to allow for complete and thorough QA testing.
To report the project as 'complete' on time and defer the remaining QA testing to a 'post-release patching' phase. (correct answer)
To pull resources from other projects to crash the QA testing schedule and finish it before the deadline.
To accurately report the project's delayed status and provide a revised timeline for completion.

Explanation: The correct answer is B. The performance measure focuses solely on meeting the timeline, not on the quality of the completed product. This creates a strong incentive for the manager to game the definition of 'complete.' By reporting the project as finished on time and re-labeling the essential remaining work, the manager can meet their performance goal. This leads to a distortion of the project's true status and can result in a lower-quality product being released. A and D would result in a negative performance evaluation. C is a possible project management technique, but if time is too short, gaming the reporting (B) is a more direct way to satisfy the performance metric.

Question 18

A manager's bonus is based on achieving a specific budgeted profit target, with no additional reward for exceeding it. The manager's division is on track to significantly exceed its profit target for the year. Which of the following actions would be the most likely form of budget gaming for this manager to engage in before the end of the year?

Selling a major asset at a gain to further increase the current year's profit.
Delaying necessary equipment maintenance from the current period to the next period.
Creating a 'cookie jar reserve' by prepaying for next year's advertising campaign in the current period. (correct answer)
Lobbying senior management for a higher, more challenging profit target for the next fiscal year.

Explanation: The correct answer is C. When performance is significantly above a target and there is no reward for the excess, managers are incentivized to 'bank' the strong performance for a future period. By accelerating discretionary expenses (like prepaying for advertising) into the current period, the manager reduces the current year's 'excess' profit and simultaneously reduces the expenses that will need to be recognized in the next period. This makes achieving next year's target easier. This practice is known as creating 'cookie jar reserves.' A would increase current profit, which provides no benefit to the manager. B is the opposite action; it would further increase current profit. D is counter to the manager's self-interest in having achievable targets.

Question 19

A technology company's performance management system heavily penalizes managers for exceeding their departmental expense budget by more than 2%. It also discourages underspending, viewing a result of less than 98% of budget as a sign of poor planning. A department manager is halfway through the year and has spent 40% of her budget. She then discovers a new software tool that would cost 15% of her total annual budget but would significantly increase her team's productivity for years to come. What is the manager's primary incentive in this situation?

To delay the purchase of the software until the beginning of the next budget cycle to ensure it can be properly budgeted for. (correct answer)
To reject the software purchase outright because it is not in the original budget and would lead to a negative performance review.
To purchase the software immediately to capture the productivity benefits as soon as possible, and explain the budget overrun to senior management.
To find deep, offsetting cuts in other planned expenditures to afford the new software while remaining within the budget corridor.

Explanation: The correct answer is C. The rigid budgeting system, with its narrow band of acceptable performance, incentivizes risk-averse behavior. The manager knows that exceeding the budget will result in a penalty. The most likely course of action is to postpone the decision until the next year, where the significant expenditure can be included in the budget proposal from the outset. This avoids the penalty, even though it means the company forgoes several months of productivity gains. A is unlikely given the heavy penalty. B is possible, but if the tool is truly valuable, the manager would likely want to acquire it eventually. D is a potential option, but finding such deep cuts (15% of the total budget) mid-year is often impractical or would require sacrificing other critical activities.

Question 20

A division of a large corporation is evaluated based on its Return on Investment (ROI). The division currently has an ROI of 22%. The division manager is presented with a potential capital investment opportunity that is expected to yield an ROI of 18%. The company's minimum required rate of return (cost of capital) is 12%. From the perspective of maximizing the division's reported performance metric, what is the manager incentivized to do?

Accept the project because its ROI exceeds the company's minimum required rate of return, thus increasing the firm's overall value.
Reject the project because its ROI is below the division's current average ROI, which would dilute the division's reported performance. (correct answer)
Accept the project because any investment with a positive ROI contributes positively to the division's financial results.
Request that the project be funded at the corporate level so that its assets and income are not included in the division's ROI calculation.

Explanation: The correct answer is B. This scenario illustrates a classic problem of goal incongruence when using ROI as a performance measure. Although the project is economically viable for the company (18% ROI > 12% cost of capital), accepting it would lower the division's average ROI from 22%. Since the manager is evaluated on the division's ROI, they are incentivized to reject the project to protect their performance metric. A describes the economically rational decision for the company as a whole, but not the decision incentivized by the performance measure. C is incorrect as not all positive ROI projects are desirable; the benchmark is the cost of capital. D is a potential workaround but the direct incentive created by the evaluation system is to reject the project outright.