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.
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[megamind]

It is also better to use residual income in the undertaking of the new
project because the use of *ROI* will reject any potential projects. The
reason for this is that ROI yields lower returns on the initial
investment whereas the residual income will maximize the income and not
the return on investment.

This clearly shows that assessing the performance of the project with
*residual income (RI)* is a better option since it provides a better
analysis, and it is better for managers to adopt RI when gauging a
potential project since it increases the profitability.

[olaadeyemoabraham]

Thank you for this concise and straight to the point video

[KylesWorld.]

Thanks for the video! One question I have is, why isn't ROI calculated on a per-project basis? Wouldn't that eliminate the distortion without having to use a more abstract metric like "residual income."

[YasmínHarbinson]

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[PoojaSharma-lhju]

Your examples in the topics are very interesting 😍

[ludiogot]

Your explanation is on point . Thank you . Could you in future consider changing your background to a lighter colour ? Black is strenuous to the eye

[maxmudbekmurodov]

Thank you for the decent explanation).

[andrewjason]

Can anyone tell me whether the residual income income excludes taxes or not ?

[rafaelpedro]

Proof that if you dig enough..you will find a loophole

[vanvuongdo]

the sound is not good I am quite disappointed