Present Value Table Factor (a) 3.790787 (Table 2, 10%, 5 Yr.)
This is what I came up with?
Cash inflows (b) $91,000 $90,000 $70,000
Present value (a x b) 344,961.62 341,170.83 265,355.09
Cost of investment -250,000.00 -250,000.00 -250,000.00
Net present value 94,961.92 91,170.83 15,355.09


Bonus if $90,000 is used as the projected annual cash inflow =
(NPV Actual – NPV Projected) * 10%

Bonus if $70,000 is used as the projected annual cash inflow =
(NPV Actual – NPV Projected) * 10%





I begun to try and figure this out, but feel that it is incorrect and I am not doing this correct. Please help me…



QUESTION:
Gaines Company recently initiated a post audit program. To motivate employees to take the
program seriously, Gaines established a bonus program. Managers receive a bonus equal to
10 percent of the amount by which actual net present value exceeds the projected net present
Value. Victor Holt, manager of the North Western Division, had an investment proposal on
his desk when the new system was implemented. The investment opportunity required a
$250,000 initial cash outflow and was expected to return cash inflows of $90,000 per year for
the next five years. Gaines' desired rate of return is 10 percent. Mr. Holt immediately reduced
the estimated cash inflows to $70,000 per year and recommended accepting the project.

a. Assume that actual cash inflows turn out to be $91,000 per year. Determine the amount
of Mr. Holt's bonus if the original computation of net present value were based on $90,000
versus $70,000.
b. Speculate about the long-term effect the bonus plan is likely to have on the company.
c. Recommend how to compensate managers in a way that discourages gamesmanship.

Are you trying for the prize, posting the same question three times will not get you an answer

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Originally Posted by paraclete

are you trying for the prize, posting the same question three times will not get you an answer

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I swear I did not mean to post that many times... I am sooooo sorry.

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Originally Posted by scriv

I swear I did not mean to post that many times... I am sooooo sorry.

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How do you delete the post you do not want to be answered. Your help would be greatly appreciated.

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Originally Posted by scriv

How do you delete the post you do not want to be answered. Your help would be greatly appreciated.

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Go to your profile and find where your questions are listed

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Originally Posted by scriv

Present Value Table Factor (a) 3.790787 (Table 2, 10%, 5 Yr.)
This is what I came up with?
Cash inflows (b) $91,000 $90,000 $70,000
Present value (a x b) 344,961.62 341,170.83 265,355.09
Cost of investment -250,000.00 -250,000.00 -250,000.00
Net present value 94,961.92 91,170.83 15,355.09

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All of your present value and NPV computations (bold rows) are correct. Now determining the managers' bonus under the two cases will be straightforward. Good work so far, keep rocking with it.

This is the answer that I got.. could you tell me if this is correct?

Thank You so much for your assistance.

Cash inflows (b) $91,000 $90,000 $70,000
Present value (a x b) 344,961.62 341,170.83 265,355.09
Cost of investment -250,000.00 -250,000.00 -250,000.00
Net present value 94,961.92 91,170.83 15,355.09
Net Projected Value 450,000.00 350,000.00
358,829.17*10% 33,464.49*10%
Bonus 35,882.92 33,464.49

Quote:

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Originally Posted by scriv

Cash inflows (b) $91,000 $90,000 $70,000
Present value (a x b) 344,961.62 341,170.83 265,355.09
Cost of investment -250,000.00 -250,000.00 -250,000.00
Net present value 94,961.92 91,170.83 15,355.09
Net Projected Value 450,000.00 350,000.00
358,829.17*10% 33,464.49*10%
Bonus 35,882.92 33,464.49

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Your NPV results are correct (the bold and italicized line). But then you stray from the bonus formula you quoted in your first post.

The bonus is 10% of the amount by which the actual NPV (the first amount in your correct NPV line) exceeds the projected NPV (the second and third amounts on that line).

The second amount on your correct NPV line is the NPV the project is expected to have, before Holt doctored the cash flows in order to juice up his bonus. The third amount on your NPV line is the project's projected NPV after Holt pulled his fast one.

Have another go at it.

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Originally Posted by ArcSine

Your NPV results are correct (the bold and italicized line). But then you stray from the bonus formula you quoted in your first post.

The bonus is 10% of the amount by which the actual NPV (the first amount in your correct NPV line) exceeds the projected NPV (the second and third amounts on that line).

The second amount on your correct NPV line is the NPV the project is expected to have, before Holt doctored the cash flows in order to juice up his bonus. The third amount on your NPV line is the project's projected NPV after Holt pulled his fast one.

Have another go at it.

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I used the 450,000 and 350,000 because of the figures that were given by my professor. I guess I should have included this along with the question in order for you to see what I was to do. I do apologize.


I have created a Word-based template to assist you in Analyzing the manager's bonus amounts based on the two different scenarios (projected $90,000 annual cash inflow vs. projected $70,000 annual cash inflow). Note, 5 years of $90,000 per year equals $450,000 of total cash received over the duration of the project ($350,000 for 2nd project). But, due to the time value of money (i.e. inflation) that $450,000 cash received is not worth that amount in today's dollars.

You first need to determine what the PV of the cash inflows are for each of the two projects. Then, you need to determine the Net Present Value of that project (PV Cash Inflows - Cost of Investment). Once you have the NPV of the two projects AND what actually occurred, then use the bonus structure of the company to calculate the manager's bonus for each of the two projects: (NPV Actual - NPV Project #1) * 10%.

Subject: Re: Open Discussion Author: Dr. John R. Kuhn Date: 6/12/2012 Body: Project projection #1 = $90,000 x 5 years = $450,000 total expected cash inflows

Project projection #2 = $70,000 x 5 years = $350,000 total expected cash inflows.

These are the new answers that I came up with.
Present Value Table Factor (a) 3.790787 (Table 2, 10%, 5 Years)

Cash inflows (b) $91,000 90,000 $70,000
Present value (a x b) 344,961.62 341,170.83 265,355.09
Cost of investment -250,000.00 -250,000.00 -250,000.00
Net present value 94,961.92 91,170.83 15,355.09
Net Projected Value 94,961.92 94,961.92
3,791.09*10% 79,606.83*10%

Bonus 379.11 7,960.68

Correct!

While the 450K and 350K (5 x 90K and 70K, respectively) amounts do indeed have some usefulness in their own right for certain purposes, they don't directly play a role in answering this particular question. In this case the 450K and 350K cash flow totals are just smokescreens you have to look past in getting to the answer.

Answers to (b) and (c) are more subjective; you'll just have to look at the results of part (a) to see what a manager can do if given unfettered rein to "estimate" the project's expected cash flows in advance. Then decide what steps might be taken to prevent managers like Holt from gaming the system.

Best of luck with your studies.

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Originally Posted by ArcSine

Correct!

While the 450K and 350K (5 x 90K and 70K, respectively) amounts do indeed have some usefulness in their own right for certain purposes, they don't directly play a role in answering this particular question. In this case the 450K and 350K cash flow totals are just smokescreens you have to look past in getting to the answer.

Answers to (b) and (c) are more subjective; you'll just have to look at the results of part (a) to see what a manager can do if given unfettered rein to "estimate" the project's expected cash flows in advance. Then decide what steps might be taken to prevent managers like Holt from gaming the system.

Best of luck with your studies.

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Thank You so much!! Have a good day!!