Taejeah

Question 1
Why is it considered necesary to use residual income to measure performance rather than ROI?

Question 2
Why residual income might influence an investment centre manager's investment decision differently?

Jocelynn

Question 1
Why is it considered necessary to use residual income to measure performance rather than ROI?

RI will overcome some of the perceived shortcoming of ROI (dysfunctional decisions, retaining ageing and inefficient assets, etc).

Different division can use different rates to reflect different risk when calculating RI.

ROI is a profit based measure and has poor correlation with shareholder value. This conflicts with the overall objective of the organisation which is to maximise the shareholder's wealth. RI will eliminate the lack of goal congruence.

Jocelynn

Question 2
Why residual income might influence an investment centre manager's investment decision differently?



The imputed interest charge is made by reference of the company’s cost of capital, so that a positive RI arises if the proposed investment generates a return higher than the required minimum.


Investment centre manager assessed on the basis of RI will therefore choose to accept all projects with a positive RI, increasing the company’s overall return.


RI encourages long-term investment decisions.