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.

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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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