Perry plc is a large conglomerate company structured on a divisional basis. It seeks to maximise investor wealth. Head office avoids day to day involvement in divisional affairs and only intervenes if performance is considered unsatisfactory. Divisional performance is measured by residual income.

One of Perrys larger divisions operates a chain of high-class hotels throughout the United Kingdom. The divisions mission statement is To be the hotel of the first choice for business users and tourists. Although the chain has generally been popular with tourists it is not proving quite so popular with business users and conference organisers. Competition in the top segment of the hotel market is fierce, with customers expecting the highest standards of facilities, service, and catering. Over the last two years, the division has invested a large amount of money in modernising its hotels including the improvement of bedrooms and public rooms, installation of gymnasia and swimming pools and the information technology features required by business travelers. A large amount of money has also been spent on staff training to improve service levels and on a television advertising campaign to promote improved hotels to business users.

Head office is concerned that the performance of the hotel chain appears to have declined over the last few years despite this expenditure.

The following figures are available

	$ millions	$ millions	$ millions
	2016	2017	2018
Capital employed	50	70	90
Operating profit	15	16	17

The cost of capital applicable to the hotel division is 20% per annum

Required:

(a) Calculate the residual income for the hotel chain for each of the three years.

(b) Discuss three advantages and four disadvantages of residual income as a divisional performance measure.