In order to avoid suboptimization, many companies prefer to evaluate their investment centers using
A) Return on investment instead of residual income.
B) Residual income instead of return on investment.
C) Gross margin instead of contribution margin.
D) Sales instead of income.

Question

Quizplus · Accepted Answer

Residual income takes into consideration the opportunity cost of the invested capital and ensures that investment decisions lead to long-term profitability. Return on investment (ROI) only focuses on the percentage return and can encourage suboptimization if managers prioritize high ROI initiatives that may not necessarily benefit the company overall. Gross margin and contribution margin are both useful metrics for evaluating profitability, but do not address the potential opportunity cost of invested capital like residual income does. Sales alone do not take into consideration the cost of goods sold or the value generated by investments, so it is not sufficient for evaluating investment centers.

In Order to Avoid Suboptimization, Many Companies Prefer to Evaluate