Residual income is a better measure for performance evaluation of an investment center manager than return on investment (ROI)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) returns do not increase as assets are depreciateD.
Problems in measuring the asset base,gross versus net book values,and cost of capital are present in both residual income and ROI.Residual income avoids the suboptimization problem with high return divisions.

Question

Quizplus · Accepted Answer

Residual income is a better measure for performance evaluation of an investment center manager than return on investment (ROI) because desirable investment decisions will not be neglected by high return divisions. This is because residual income takes into account the opportunity cost of the funds tied up in an investment, whereas ROI only considers the return on the investment. As a result, high return divisions may be incentivized to neglect investments with lower returns that would ultimately benefit the overall performance of the investment center. Residual income also eliminates the problems associated with measuring the asset base and only requires the calculation of net book value. However, ROI and residual income both suffer from issues related to the cost of capital.

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