Return on Investment; Goal Congruence Issues As indicated in the chapter, return on investment (ROI) is well entrenched in business practice. However, its use can have negative incentiveeffects on managerial behavior. For example, assume you are the manager of an investment centerand that your annual bonus is a function of achieved ROI for your division. You have the opportunityto invest in a project that would cost $500,000 and that would increase annual operating income ofyour division by $50,000. (This level of return is considered acceptable from top management’sstandpoint.) Currently, your division generates annual operating profits of approximately $600,000,on an asset base (i.e., level of investment) of $4,000,000.Required1. What is the current return on investment (ROI) being realized by your division (i.e., before consideringthe new investment)?2. What would happen to the near-term ROI of your division after adding the effect of the new investment?3. As manager of this division, given your incentive compensation plan, would you be motivated to makethe new investment? Why or why not?4. Can you offer any recommendations for improving the design of the incentive compensation plan underwhich you are working? That is, can you think of a plan that would result in increased alignment of yourincentives with the goals of the company?
effects on managerial behavior. For example, assume you are the manager of an investment center
and that your annual bonus is a function of achieved ROI for your division. You have the opportunity
to invest in a project that would cost $500,000 and that would increase annual operating income of
your division by $50,000. (This level of return is considered acceptable from top management’s
standpoint.) Currently, your division generates annual operating profits of approximately $600,000,
on an asset base (i.e., level of investment) of $4,000,000.
Required
1. What is the current return on investment (ROI) being realized by your division (i.e., before considering
the new investment)?
2. What would happen to the near-term ROI of your division after adding the effect of the new investment?
3. As manager of this division, given your incentive compensation plan, would you be motivated to make
the new investment? Why or why not?
4. Can you offer any recommendations for improving the design of the incentive compensation plan under
which you are working? That is, can you think of a plan that would result in increased alignment of your
incentives with the goals of the company?
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