Residual income is a better measure for performance evaluation of an investment center manager than return on investment because (CMA adapted)
A)The problems associated with measuring the asset base are eliminated.
B)Desirable investment decisions will not be neglected by high-return divisions.
C)Only the gross book value of assets needs to be calculated.
D)The arguments about the implicit cost of interest are eliminated.

Question

Quizplus · Accepted Answer

Return on investment measures the profitability of an investment center manager based on the ratio of income to assets invested, but it does not take into account the level of investment required to generate that income. A manager may be generating a high return on investment but may be neglecting necessary investments or projects that could create even higher returns. Residual income, on the other hand, measures the income generated by an investment center manager less a charge for the assets used in generating that income. This eliminates the problems associated with measuring the asset base and arguments about the implicit cost of interest, while also providing a better measure of the manager's ability to make profitable investment decisions. Therefore, residual income is a better measure for performance evaluation of an investment center manager than return on investment.

Residual Income Is a Better Measure for Performance Evaluation of an Investment