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The BPP revision kit says the following statement is true:
“Residual income does not facilitate comparisons between investment centres.”
Is it becasue investment centres have different cost of capital
or just because its not a percentage or ratio value?Thank you as always.
Residual income does not facilitate comparisons because they are not directly comparable across organisations or business units due to differences in capital structures, risk profiles, or industry dynamics.
Each investment center may have different levels of invested capital and varying cost of capital, making it difficult to compare their residual income figures.
The size of the division or investment center can significantly impact the residual income. A larger division may show a higher residual income simply because of its size, rather than superior managerial performance. This makes it challenging to assess and compare the actual performance of investment centers accurately.
Additionally, the subjectivity in determining the appropriate cost of capital can further hinder the comparability of residual income between investment centers. Different assumptions or methodologies used in estimating the cost of capital can lead to variations in residual income calculations, making it less suitable for absolute comparisons.
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