A company may prefer to use residual income over return on investment for performance evaluation because:
A)return on investment is absolute figure but residual income is a ratio.
B)residual income is more likely to lead to goal congruence than return on investment.
C)it is easier to calculate residual income than return on investment.
D)residual income considers three elements but return on investment considers only two elements.

Question

Quizplus · Accepted Answer

Residual income is calculated by deducting a minimum required rate of return from the net operating income. This means that managers are only rewarded for investments that generate more than the minimum required rate of return. Therefore, residual income is more likely to lead to goal congruence as it motivates managers to make investments that are profitable for the company as a whole. Return on investment, on the other hand, is an absolute figure that does not take into account the cost of capital or the minimum required rate of return. This means that managers could invest in projects with low returns as long as they generate a positive return on investment, which may not be beneficial for the company.

A Company May Prefer to Use Residual Income Over Return