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Strategic Performance Management and Business Valuation · Performance Measurement, Evaluation and Improvement Tools

Divisional Performance: ROI, Residual Income and EVA

Updated 11 October 2026 · Fact-checked

ROI, residual income and EVA measure how well a division uses capital. ROI = operating profit ÷ capital employed. Residual income = operating profit − (capital employed × required return). EVA = NOPAT − (invested capital × WACC). To solve, find profit, find capital, apply the rate, compare, and recommend.

Understand Divisional Performance: ROI, Residual Income and EVA

A divisional manager controls profit and the assets used to earn it. Profit alone is not enough. A division earning ₹50 lakh on ₹2 crore of assets is better than one earning ₹60 lakh on ₹5 crore. So we link profit to capital.

Return on Investment (ROI) gives a percentage. It is easy to understand and compare across divisions. Its flaw is that it can push managers to reject good projects. A manager whose division earns 25% may refuse a project returning 18%, even if the company's cost of capital is 12%. That project would add value, but it would lower the division's ROI.

Residual Income (RI) fixes this by showing profit in rupees after charging for capital. A project with a return above the required rate adds to RI, so the manager accepts it. The weakness is that RI is an absolute amount, so large divisions look better than small ones. It is hard to compare divisions of different size.

Economic Value Added (EVA) is a refined form of RI. It starts with after-tax operating profit (NOPAT) and charges for capital at the weighted average cost of capital (WACC). It also adjusts accounting figures that distort economic profit. For example, R&D or training can be capitalised, and one-off items removed. A positive EVA means value is created for investors.

In the exam, you are usually given data and asked to compute all three, compare them, and say which division is doing better and what decision follows.

Key rules to remember

Return on Investment
ROI = (Divisional profit ÷ Capital employed) × 100
Use the profit and capital definitions the question gives. Be consistent: if you use closing or average capital, state it.
Residual Income
RI = Divisional profit − (Capital employed × Required rate of return)
The charge for capital is called the imputed interest or capital charge. Result is in rupees.
NOPAT
NOPAT = EBIT × (1 − tax rate)
Apply tax to operating profit, not to profit after interest. Adjust EBIT first if the question asks.
Economic Value Added
EVA = NOPAT − (Invested capital × WACC)
Invested capital is usually equity plus debt (net operating assets). Use the WACC given or compute it.
WACC
WACC = (E ÷ V) × Ke + (D ÷ V) × Kd × (1 − t)
E and D are market or stated values, V = E + D. Cost of debt is after tax.
Project test under ROI and RI
Accept under RI if project return > required rate; accept under ROI if project return > current divisional ROI
This explains why the two measures can give different decisions.

How to solve Divisional Performance: ROI, Residual Income and EVA questions

Use the same sequence for any question on ROI, RI or EVA. It keeps your working clear and earns method marks.

  1. 1Read what the question asks: ROI, RI, EVA, a comparison, or a project decision. Note the required rate or WACC.
  2. 2Identify the profit figure: divisional operating profit for ROI and RI, or NOPAT for EVA. Make any adjustments given, such as adding back R&D or removing one-offs.
  3. 3Identify the capital figure: capital employed or invested capital. Adjust it if an expense was capitalised. State whether you use opening, closing or average.
  4. 4Compute ROI as profit ÷ capital × 100.
  5. 5Compute the capital charge as capital × rate, then RI or EVA as profit minus the charge.
  6. 6For project questions, recompute ROI and RI with and without the project and compare the changes.
  7. 7Compare divisions and comment on goal congruence, size effect and short-term bias.
  8. 8Give a clear recommendation in one or two sentences.

Quickest way: Capital charge first, then compare

When to use it: Use when the question gives several divisions or a project and asks for a quick ranking or accept/reject decision.

  1. Write profit and capital for each division in a small list.
  2. Compute ROI mentally as profit ÷ capital.
  3. Compute the capital charge and subtract from profit to get RI or EVA.
  4. For a new project, skip full recalculation: compare the project's return with the required rate for RI, and with the current ROI for ROI.
  5. Write one line on the conflict if ROI and RI point different ways.

Common mistakes in Divisional Performance: ROI, Residual Income and EVA

  • Using profit after interest and tax for ROI or RI.

    Students take the last profit figure in the data.

    Fix: Use divisional operating profit (before interest, and usually before tax unless told otherwise). For EVA use NOPAT, which is operating profit after tax but before interest.

  • Deducting interest and also charging the capital charge.

    Interest is already in the profit figure, so cost of capital is counted twice.

    Fix: Start from profit before interest. The capital charge already covers the cost of funds.

  • Using the cost of debt alone as WACC in EVA.

    Students forget equity has a cost too.

    Fix: Compute WACC with both equity and after-tax debt, weighted by their proportions.

  • Ignoring adjustments such as capitalised R&D in EVA.

    Students treat EVA as plain RI.

    Fix: Read the data for items to add back to profit and to capital. Apply the tax effect if the question gives the tax rate.

  • Saying RI is better because it is higher for the bigger division.

    RI is in rupees and grows with size.

    Fix: Comment that RI is not suitable for comparing divisions of different size. Compare ROI too, and judge against the capital charge.

  • Accepting or rejecting a project on ROI alone without comparing to the required rate.

    Students focus on the division's current ROI.

    Fix: Test the project against both the current ROI and the required return, and explain the goal congruence issue.

Worked examples

Example 1

Division X has operating profit of ₹60 lakh and capital employed of ₹4 crore. Division Y has operating profit of ₹36 lakh and capital employed of ₹2 crore. The company's required return is 12%. Compute ROI and RI for each division and comment.

Show the solution
  1. Division X ROI = 60,00,000 ÷ 4,00,00,000 × 100 = 15%.
  2. Division Y ROI = 36,00,000 ÷ 2,00,00,000 × 100 = 18%.
  3. Capital charge X = 4,00,00,000 × 12% = ₹48,00,000. RI of X = 60,00,000 − 48,00,000 = ₹12,00,000.
  4. Capital charge Y = 2,00,00,000 × 12% = ₹24,00,000. RI of Y = 36,00,000 − 24,00,000 = ₹12,00,000.
  5. Both divisions have the same RI, but Y earns a higher ROI on a smaller capital base.

Answer: ROI: X 15%, Y 18%. RI: X ₹12,00,000, Y ₹12,00,000. Both add equal rupee value over the required return, while Y uses capital more efficiently. Y has more room to grow profitably, so extra capital could be directed to Y if it finds projects above 12%.

Example 2

Meridian Ltd has EBIT of ₹90 lakh. The tax rate is 30%. Invested capital is ₹5 crore, financed 60% by equity at 15% cost and 40% by debt at 10% pre-tax cost. Compute NOPAT, WACC and EVA.

Show the solution
  1. NOPAT = 90,00,000 × (1 − 0.30) = ₹63,00,000.
  2. After-tax cost of debt = 10% × (1 − 0.30) = 7%.
  3. WACC = 0.60 × 15% + 0.40 × 7% = 9% + 2.8% = 11.8%.
  4. Capital charge = 5,00,00,000 × 11.8% = ₹59,00,000.
  5. EVA = 63,00,000 − 59,00,000 = ₹4,00,000.

Answer: NOPAT ₹63,00,000; WACC 11.8%; EVA ₹4,00,000. EVA is positive, so the company earns more than its cost of capital and creates value for investors.

Exam tips

  • Always show the capital charge line separately. Marks are often given for it even if the final figure is wrong.
  • State your assumptions on profit and capital (before or after tax, opening, closing or average) in one line.
  • In comparison questions, add a short comment on goal congruence and size bias. Numbers alone rarely earn full marks.
  • For EVA, scan the data for adjustments such as R&D, goodwill written off or one-time gains before you compute NOPAT.
  • Close with a recommendation. Case-based answers are judged on the decision, not just the arithmetic.

Practice questions from Performance Measurement, Evaluation and Improvement Tools

Divisional Performance: ROI, Residual Income and EVA in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Divisional Performance: ROI, Residual Income and EVA: frequently asked questions

What is the difference between ROI and residual income?

ROI is a percentage that links divisional profit to capital. Residual income is a rupee amount left after charging for capital at the required rate. RI avoids the problem where managers reject projects that earn more than the cost of capital but less than the current ROI.

How do I calculate EVA step by step?

First find EBIT and adjust it if needed. Multiply by (1 − tax rate) to get NOPAT. Find invested capital and WACC, then multiply them to get the capital charge. Subtract the capital charge from NOPAT.

How is EVA different from residual income?

Both subtract a capital charge from profit. EVA uses NOPAT, the WACC and accounting adjustments to reflect economic profit. RI is usually based on divisional operating profit and a required rate set by the company.

Which measure is best for comparing divisions of different size?

ROI is easier to compare because it is a percentage. RI and EVA are absolute amounts and favour larger divisions. In an answer, use ROI for comparison of efficiency and RI or EVA for judging value added.