As indicated in the chapter, ROI is well entrenched in business practice. However, its use can have negative incentive 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 an opportunity to invest in a project that would cost $500,000 and that would increase annual operating income 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., leve of investment) of $4,000,000.

Problem Information

Estimated cost of proposed project = 500000

Estimated increase in annual op. profit = 50000

Current level of operating profit = 600000

Current level of assets (investment) = 4000000

Requirements:

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 goal congruency between your incentives and the goals of the company?