12-12 If ROI is used to evaluate performance,
price can lead to incorrect decisions. When the
a manager of an investment center may reject a
profitable investment opportunity whose rate of
selling division has idle capacity, the cost to the
company of the transfer is just the variable cost
return exceeds the company’s required rate of
of the item transferred. However, if the market
return but whose rate of return is less than the
investment center’s current ROI. The residual
price is used as the transfer price, the buying
division regards the market price as the cost. If
income approach overcomes this problem since
the market price exceeds the variable cost
any project whose rate of return exceeds the
(which will ordinarily happen), managers in the
company’s minimum required rate of return will
result in an increase in residual income.
buying division will make less than optimal pric-
ing and other decisions concerning the product.
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