operating income that an investment center is able to earn above some minimum return on its assets. It is a popular alternative performance measure to Return On Investment (ROI). RI is computed as:
RI = Net Operating Income - (Minimum Rate of Return on Investment ¥ Operating Assets)
Residual income, unlike ROI, is an absolute amount of income rather than a rate of return. When RI is used to evaluate divisional performance, the objective is to maximize the total amount of residual income, not to maximize the overall ROI percentage figure. For example, assume that operating assets are $100,000, net operating income is $18,000, and the minimum return on assets is 13%. Residual income is $18,000 - (13% ¥ $100,000) = $18,000 - $13,000 = $5000. RI is sometimes preferred over ROI as a performance measure because it encourages managers to accept investment opportunities that have rates of return greater than the charge for invested capital. Managers being evaluated using ROI may be reluctant to accept new investments that lower their current ROI, although the investments would be desirable for the entire company. Advantages of using residual income in evaluating divisional performance include: (1) it takes into account the opportunity cost of tying up assets in the division; (2) the minimum rate of return can vary depending on the riskiness of the division; (3) different assets can be required to earn different returns depending on their risk: (4) the same asset may be required to earn the same return regardless of the division it is in; and (5) the effect of maximizing dollars rather than a percentage leads to goal congruence.
