A company may prefer to use residual income over return on investment for performance evaluation because ________.
A)residual income is a ratio but return on investment is an absolute figure
B)residual income is more likely to lead to goal congruence than return on investment is
C)residual income is easier to calculate 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 preferred over return on investment because it is more likely to lead to goal congruence. This is because residual income takes into account the cost of capital, which incentivizes managers to invest in projects that generate returns above the cost of capital. Return on investment, on the other hand, does not consider the cost of capital and may incentivize managers to invest in projects that generate high returns but do not generate value for the company.

A Company May Prefer to Use Residual Income Over Return