Discuss one potential problem that might be experienced as a result of using ROI to appraise the performance of the divisions.Recommend one alternative performance measure that could be used to address this problem.
The use of ROI as a performance measure might lead to dysfunctional behaviour by divisional managers. They might be tempted to avoid investing capital in their respective divisions. This would reduce the average capital employed in order to achieve a higher level of ROI.
Residual income (Rl) is an alternative measure of divisional performance. It encourages divisional managers to make new investments if they add to Rl. A new investment might add to Rl but reduce ROI. In such a situation, measuring the performance by Rl would reduce the probability of dysfunctional behaviour.
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