Residual income is superior to return on investment as a means of measuring performance because it encourages managers to make investment decisions that are more consistent with the interests of the company as a whole.

Question

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Residual income takes into account the cost of capital and encourages managers to make investments that generate returns above that cost, whereas return on investment only measures the return generated by the investment itself. This helps to ensure that investments are made in projects that add value to the company as a whole, rather than just generating a high return on investment.

Residual Income Is Superior to Return on Investment as a Means