(Pay plan and suboptimization) Susan Smyth is a division manager of Midwest Manufacturing Inc. She is presently evaluating a potential revenue-generating investment that has the following characteristics:

The project would have a 5-year life with no salvage value. All assets are depre¬ ciated according to the straight-line method. Susan is evaluated and compensated based on the amount of pretax profit her division generates. More precisely, she receives an annual salary of $200,000 plus a bonus equal to 2 percent of divisional pretax profit. Before consideration of the above project, Susan anticipates that her division will generate $2,000,000 in pretax profit.

a. Compute the effect of the new investment on the level of divisional pretax profits for years 1 through 5.

b. Determine the effect of the new project on Susan’s compensation for each of the 5 years.

c. Based on your computations in part

b, will Susan be hesitant to invest in the new project? Explain.

d. Would upper management likely view the new investment favorably? Explain.

Initial cost $2,000,000 Net annual increase in divisional income before consideration of depreciation: Year 1 Year 2 Year 3 Year 4 Year 5 $ 200,000 300,000 380,000 1,600,000 1,600,000