The main drawback with ROI is it can lead to sub-optimal decision-making. If a divisional manager’s performance is to be appraised by ROI he/she will be unwilling to accept projects which do not realise a return at least equal to the current ROI being earned by that division.
The manager would be inclined to reject the project since it would dilute the ROI. Let’s suppose the company’s overall cost of capital is 10%. Any project which delivers a return in excess of 10% increases the wealth of the company. This is sub-optimal planning and decision-making.
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