Residual income is a better evaluation method than return on investment because it has a lower required rate of return for the company projects than return on investment does.

Question

Quizplus · Accepted Answer

Residual income and return on investment are both methods used for evaluating whether an investment or project is profitable. However, residual income takes into account the cost of capital and subtracts it from the project's net income, which gives a more accurate representation of how much the project is contributing to the company's bottom line. Return on investment, on the other hand, only considers the percentage return on the investment, without factoring in the cost of capital. Therefore, return on investment generally has a higher required rate of return for the company's projects than residual income, making it a less attractive evaluation method.

Residual Income Is a Better Evaluation Method Than Return on Investment