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ROI vs. Residual Income

This video discusses the difference between ROI and Residual Income. Both ROI and Residual Income are metrics frequently used to evaluate a division's profitability. However, ROI is expressed as a percentage whereas Residual Income is expressed as a unit of currency (e.g., dollars). This makes ROI more attractive because it is easier for managers to understand a percentage. However, ROI has a significant disadvantage relative to Residual Income. ROI may lead to suboptimal decisions if a divisional manager rejects a project that would increase the value of the overall firm but would decrease the division's ROI. For example, if the division's ROI is currently 32%, the divisional manager might reject a project that has an ROI of 27% because it would reduce the ROI of the division (even though it might benefit the company as a whole). The use of Residual Income does not lead to this problem; when divisional managers are evaluated based on Residual Income, they have an incentive to accept any projects that earn a return higher than the amount the division is being charged for its capital. — Edspira is the creation of Michael McLaughlin, an award-winning professor who went from teenage homelessness to a PhD. Edspira’s mission is to make a high-quality business education accessible to all people. — SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO THE FINANCIAL STATEMENTS, PLUS: • A 23-PAGE GUIDE TO MANAGERIAL ACCOUNTING • A 44-PAGE GUIDE TO U.S. TAXATION • A 75-PAGE GUIDE TO FINANCIAL STATEMENT ANALYSIS • MANY MORE FREE PDF GUIDES http://eepurl.com/dIaa5z — GET CERTIFIED IN FINANCIAL STATEMENT ANALYSIS, IFRS 16, AND ASSET-LIABILITY MANAGEMENT https://edspira.thinkific.com — LISTEN TO THE SCHEME PODCAST Apple Podcasts: https://podcasts.apple.com/us/podcast... Spotify: https://open.spotify.com/show/4WaNTqV... Website: https://www.edspira.com/podcast-2/ — GET TAX TIPS ON TIKTOK   / prof_mclaughlin   — ACCESS INDEX OF VIDEOS https://www.edspira.com/index — CONNECT WITH EDSPIRA Facebook:   / edspira   Instagram:   / edspiradotcom   LinkedIn:   / edspira   — CONNECT WITH MICHAEL Twitter:   / prof_mclaughlin   LinkedIn:   / prof-michael-mclaughlin   — ABOUT EDSPIRA AND ITS CREATOR https://www.edspira.com/about/