When do we use ROI and when we use RI? ROI = Return on investment RI = Residual Income

Agree with others, ROI shows in percentage and RI in amount or dollars

RI is favoured for reasons of goal congruence and managerial effort. Under ROI the basic objective is to maximize the rate of return percentage. Thus, managers of highly profitable divisions may be reluctant to invest in the projects with lower ROI than the current rate because their average ROI would be reduced.

On the other hand, under RI the manager would be inclined to invest in the projects earning more than the desired rate of return, i.e., the risk-adjusted cost of capital. Despite its known disadvantages, most managers agree that the rate of return on invest is the ultimate test of profitability.

Intelligently used ROI can help decision-making. However, with both measures, there remain significant problems of interpretation and measurement. It all depends on how investment and income in a decision are measured and interpreting the accounting rate of return as if it be analogous to the cost of capital.

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Instead of focusing purely on the absolute size of a division's profits, most or organisations focus on the return on investment.

ROI is the most widely used financial measure of divisional performance. It provides a useful overall approximation on the success of a firm's past investment policy by providing a summary measure of the ex post return on capital invested.

ROI is also used as a common denominator for comparing the return of dissimilar businesses, such as other divisions within the group or outside competitors.

To overcome some of the dysfunctional consequences of ROI the residual income approach can be used. For the purpose of evaluating the performance of divisional managers, residual income is defined as controllable contribution less a cost of capital charge on the investment controllable by the divisional manager.

In short both are used when assessing divisional financial performance.

agree with answers

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