This method seeks to overcome some of the deficiencies of the ROI method. It allows investment proposals to be accepted as long as they increase residual income. Any proposal will increase residual income as along as its rate or return is greater than the company’s minimum rate of return. That is, a proposal could have a rate of return greater than the company’s minimum rate of return but less than the company’s actual existing rate of return. If this was the case, the project would be rejected under ROI but accepted under Residual income because it increases residual income.
Disadvantage: the larger the segment the larger the residual income. Hence, you cannot use residual income to compare segments that are greatly different in size.