The manager of the processing division of XYZ Corporation is considering the purchase of new equipment, which would modernize an aging plant. Currently, the division has an asset base of $8,000,000 and net operating income of $1,200,000. The new equipment is expected to cost $1,000,000; it supports the corporate strategy of competing on the basis of quality and customer response time. The new investment is also expected to increase operating income by $100,000 next year, which is an acceptable return on investment from the standpoint of corporate management.
- What is the current ROI for the processing division of XYZ Corporation? (Show calculations.)
- What will be the divisional ROI if the new investment is undertaken?
- Suppose that the compensation contract for the manager of the processing division consists of a base salary plus a bonus that is proportional to the ROI earned by the division. Is this manager’s total compensation higher with or without the new investment? (Show calculations.)
- What changes to the divisional manager’s compensation contract might corporate management make that would better align divisional manager’s compensation (and performance evaluation) with overall corporate goals?