Question

Which is a better evaluation tool - return on investment or residual income? Why or why not?

Answer 1

Residual income is better in comparison with return on investment, to evaluate the performance of an investment center.The following are the main reason of it.

1) The problem associated with measuring the assets base can be eliminated because their is no need to measure any assets base.

2) When return on investment is used for evaluation ,then most of the time desirable investment decision has been rejected by higher ROI division. But in case of residual income based evaluation  desirable investment decision can't be rejected by division which already have higher ROI.

3) Only gross book value of assets to be calculated ,because rest are not to be required.

4) Returns don't increase as assets are depreciated. Because depreciation reduces the the net return.