Bilbo Company evaluates its managers on the basis of return on investment (ROI). Division Three has an ROI of 15% while the company as a whole has an ROI of only 10%. Which of the following performance measures will motivate the managers of Division Three to accept a project earning a 12% return?
A) Return on investment (ROI)
B) Residual income (RI)
C) Both ROI and RI will motivate the manager to accept the project.
D) Neither ROI nor RI will motivate the manager to accept the project.

Question

Quizplus · Accepted Answer

Residual income (RI) is a better performance measure for motivating the managers of Division Three to accept a project earning a 12% return. With an ROI of 15%, Division Three is already performing above the company's average ROI of 10%. However, using RI as a performance measure will incentivize the managers of Division Three to accept a project earning a 12% return as it will increase their division's residual income, which is the amount of income earned above the minimum required rate of return on the division's assets. Therefore, they will be motivated to accept the project if it increases their division's RI.

Bilbo Company Evaluates Its Managers on the Basis of Return