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Question:
Which of the following is not a feature of the Return on Investment performance measure?
(1) It enables the comparison of the performance of divisions of different sizes.
(2) It motivates the division manager to try to improve the company’s target rate of return.
Dear Sir,
The above is a question from the Revision Mock Exam. The indicated answer is answer “( 2)” above. Given that I chose the answer “(1)” because I can’t understand the reasoning of answer “(2)”, therefore, kindly explain to me why answer “(1)” is incorrect and answer “(2)” is correct.
If you had watched our free lectures you would not need to ask this (because it is explained in the lecture) 🙂
(our free lectures are a complete course for Paper F5 and cover everything needed to be able to pass the exam well!)Suppose your division is 10 times bigger than mine – yours has assets of 100,000 and mine only has assets of 10,000.
Which one will you expect will make the bigger profit (and therefore the bigger residual income)? Yours of course because it is so much bigger.But suppose you are making a profit of 10,000 and I am making a profit of 2,000.
It is me who is running my division better than you are. You are making an ROI of 10% but I am making an ROI of 20%.That explains why (1) is a feature of the ROI performance measure.
However, (2) is not a feature because managers who are measured on ROI are motivated to increase the ROI of their division. You want to improve your 10% and I want to improve my 20%. But neither 10% of 20% may be the target for the company as a whole.
I do suggest that you watch the lectures!
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