Question

19)

Horizon Company produces a variety of boating products. Each division manager at Horizon is paid a base salary and given an annual cash bonus if the division achieves profits of at least 12 percent of the value of assets invested in the division (this is often called return on investment).

Whereas, Kathy Bainsley, manager of the Kayak Division, is considering investing in new production equipment. The net present value of the proposal is positive, and Kathy is convinced the new equipment will provide a competitive edge for future years. Even though short-term profits will reduce the return on investment below the 12 percent requirement for the next two years, profits are expected to increase significantly beginning in year three. Unfortunately, Kathy is planning to retire in two years and this investment would prevent her from receiving her annual bonuses for the next two years. As a result, Kathy plans to reject the proposal to invest in new production equipment.

Which company action would increase the likelihood of Kathy accepting the proposal?(5pts)

a. Offering stock options.

b. Providing short-term bonuses that adjust for the negative effects of new projects.

c. Establishing policies that require review teams for new projects.

d. All of the choices increase the likelihood of Kathy accepting the proposal

e. None of the answer choices is correct.

Answer 1

Analysis of the current case: Horizon Company produces variety of boating products and each manager is paid salary plus bonus based on the profitability of the comapny when return on earning of the Company is more than or equal to 12 %.

Kathy being manager of kayak division is planning to introduce a new equipment to the Company that has a great future opportunity but give rise to lower profits in near future of two years. However NPV of the project is positive , kathy is Planning to reject the project because he is going to be retired after two years and there will be decrease in profits for next two year if we opt for the project .Due to fear of loss of bonus Kathy is planning to reject the plan of investing in new equipment.

In order to convince kathy (alongwith other managers) Company is Seeking to find out various options that can increase the likelyhood of kathy accepting the option.

Lets See the impact of all these option on the kathys` Income:

a) Providing Stock Options: Under providing Stock Options , employess of company are offered shares of company at a price lower than the traded price and employess have the option to get those shares on the decreased price within the vesting period. Employee can opt for this option if at the time of vesting , price he pays is less then the market price of share so that he could earn capital gain on such stock options . It is a kind of incentive that companies use to give to their employees in order to motivate them finanycially. Hence if market of the company is strong and Kathy ( alongwith other managers) thinks that capital gain assumed to be earned by opting the stock option will be greater than or equal to the loss of bonus used to be recieved on the basis of profitability of the company then the likelihhood of kathy accepting the option will increased.

b)Providing short term Bonus nullifying negative impact of project: As the option itself says short term bonus is provided to defuse the impact of loss of bonus due to decline in profits it will definitely impact Kathy (along with other manager) positively to accept the project

c) Estabilishing poicies that require review teams for new project: There can be two consequences of appointing review teams :

1) Members of review team will get extra salary and managers including kathy become part of that review team and get that extra salary that will compensate them for loss of bonus due decline in profits or

2) Review team will review the work of the kayak department and members of the new project will be given incentives with positive imlementation of new project and that incentives have the ability to cope up with the loss of bonus due to decline in profis to Kathy.

Hence we can conclude that all the three options will increase the likelyhood of kathy accepting the proposal of new project as the loss of bonus will get compensated with other incentives ie either a or b or c.

Hence all the 3 proposals increase the likelihood of Kathy accepting the option.