ROI has the disadvantage of encouraging managers to sacrifice long-term benefits to increase short-term gain. In particular, a manager with a high ROI may turn down profitable opportunities with somewhat lower Rols to maintain the current ROI. A measure has been developed to circumvent this, residual income. Residual income is an absolute dollar amount that compares operating Income with the return - Calculated as some preset hurdle rate (percent) times the level of average operating assets. If residual income is positive, ROI is higher than the hurdle rate. If residual income is negative, ROI is lower than the hurdle rate. It residual income is zero, Rot is equal to the hurdle rate. Examplet Jesper, Inc provided the following data on its East and West Divisions for last year: East Division West Division Operating income $95.000 $220,000 Average operating assets 920,000 2,450,000 ROI 10.33% 8.98% Jesper requires a 6% rate of return. The residual income for the East Division is $39,970 The residual income for the West Division is 62,800 Notice that while the East Division has a higher ROI than the West Division, the West Division has a higher residual income than the East Division. While this need not always be the case, it is true that larger divisions generally have a more difficult time increasing ROI because they have large asset bases However, it is relatively easier for larger divisions to generate larger residual income because they have larger operating income Both the East and the West Divisions have access to an additional $150,000 of investment. Each of the divisions could invest that amount in a new project with projected operating income of $12,000. First, assume that the divisions are evaluated on the basis of ROI. What decision will the East Division manager make with respect to the additional investment? Decline