Question

Which of the following is correct about ROI and Residual Income? One disadvantage of Residual Income is that it causes under- investment problems One disadvantage of RO is that it biases in favor of larger business units because it shows dollar results In practice, companies tend to use both measures in cyaluating performance None of the above

Answer 1

Answer is : In practice, companies tend to use both measures in evaluating performance

Residual income is a measure which computes net income after deducting imputed cost of capital from the operating income. Imputed cost of capital is average operating assets invested in division multiplied by cost of capital. Return on Investment is computed on Average operating assets invested. Both measures are useful for evaluation of investments by division. Hence companies tend to use both measures in evaluating performance.