Y Corp is a social media platform. In 2020 the company adopted a new incentive system,...

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Y Corp is a social media platform. In 2020 the company adopted a new incentive system, which rests on three pillars: 1. The performance measure is residual income, calculated by subtracting from operating income (01) a capital charge of 10% based on the net book value (NBV) of assets at the beginning of the year (see Exhibit 2 for an example). This capital charge roughly reflects the firm's cost of capital. 2. The bonus earned by any manager is calculated as a percentage (the pay performance sensitivity, PPS) of the amount by which actual residual income exceeds target residual income. Target residual income is derived by adding an improvement goal to the previous year's actual residual income (again, see Exhibit 2). 3. The bonus earned gets credited to the manager's individual bonus bank. If the balance in the bonus bank is positive at the end of a year, then half of this balance is paid out to the manager. The other half gets carried forward to future years fagain, see Exhibit 2). Over the years 2020-2023, Y experienced modest growth. In 2024 Y's key competitor has to disrupt operations for months. Y responds by expanding to capture a larger share of the market. Exhibit 1 summarizes Y's key financials for the years 20202023 and forecasted values for 2024-2026: In thousands Forecasted Values: 2020 2021 2022 2023 2024 2025 2025 GURER 20,000 22,000 23,500 25,000 31,000 23,000 24,000 860% Cash Flow 30,000 35,900 39,500 42,700 59,000 47,000 SQ,500 Depreciation 18,000 21,000 22,000 23,000 25,500 26,000 26,000 income 12,000 14,900 17,500 19,700 33,500 21,000 24,500 [Ending Net Book Value Capital Charge 110,000 111,000 11,000 112,500 11,100 114,500 11,250 120,000 117,000 115,000 11,450 12,000 11,700 In 2024, Y considers a reorganization effort involving extensive personnel training and R&D expenditures toward developing new intellectual capital labeled the "intangible." Y's business unit CFO, Zelda Braverman, weighs the available options. (For simplicity, here, we ignore anything happening after 2029, c.g., the intangible by then will be obsolete.] Generating the "Intangible" internally is expected to cost $10 million in 2024. Zelda expects operating cash flow improvements for Y starting at $3.8 million for 2025 and increasing thereafter at an annual rate of 5% till the terminal year, 2029. (Note, the increase relates to the incremental cash flow arising as a result of the intangible.) The alternative is to acquire the intangible from another firm that has the desired know-how. The acquisition cost would be $14 million in 2024, followed by expected cash flow improvements of $3.85 million in 2025, increasing thereafter at an annual rate of 3% till 2029. Y Corp is a social media platform. In 2020 the company adopted a new incentive system, which rests on three pillars: 1. The performance measure is residual income, calculated by subtracting from operating income (01) a capital charge of 10% based on the net book value (NBV) of assets at the beginning of the year (see Exhibit 2 for an example). This capital charge roughly reflects the firm's cost of capital. 2. The bonus earned by any manager is calculated as a percentage (the pay performance sensitivity, PPS) of the amount by which actual residual income exceeds target residual income. Target residual income is derived by adding an improvement goal to the previous year's actual residual income (again, see Exhibit 2). 3. The bonus earned gets credited to the manager's individual bonus bank. If the balance in the bonus bank is positive at the end of a year, then half of this balance is paid out to the manager. The other half gets carried forward to future years fagain, see Exhibit 2). Over the years 2020-2023, Y experienced modest growth. In 2024 Y's key competitor has to disrupt operations for months. Y responds by expanding to capture a larger share of the market. Exhibit 1 summarizes Y's key financials for the years 20202023 and forecasted values for 2024-2026: In thousands Forecasted Values: 2020 2021 2022 2023 2024 2025 2025 GURER 20,000 22,000 23,500 25,000 31,000 23,000 24,000 860% Cash Flow 30,000 35,900 39,500 42,700 59,000 47,000 SQ,500 Depreciation 18,000 21,000 22,000 23,000 25,500 26,000 26,000 income 12,000 14,900 17,500 19,700 33,500 21,000 24,500 [Ending Net Book Value Capital Charge 110,000 111,000 11,000 112,500 11,100 114,500 11,250 120,000 117,000 115,000 11,450 12,000 11,700 In 2024, Y considers a reorganization effort involving extensive personnel training and R&D expenditures toward developing new intellectual capital labeled the "intangible." Y's business unit CFO, Zelda Braverman, weighs the available options. (For simplicity, here, we ignore anything happening after 2029, c.g., the intangible by then will be obsolete.] Generating the "Intangible" internally is expected to cost $10 million in 2024. Zelda expects operating cash flow improvements for Y starting at $3.8 million for 2025 and increasing thereafter at an annual rate of 5% till the terminal year, 2029. (Note, the increase relates to the incremental cash flow arising as a result of the intangible.) The alternative is to acquire the intangible from another firm that has the desired know-how. The acquisition cost would be $14 million in 2024, followed by expected cash flow improvements of $3.85 million in 2025, increasing thereafter at an annual rate of 3% till 2029.