The owners of a small manufacturing concern have hired a manager to run the comp
ID: 1193416 • Letter: T
Question
The owners of a small manufacturing concern have hired a manager to
run the company with the expectation that (s)he will buy the company
after five years. The goal of the owners in making this hire is to find
the appropriate manager that will increase profits substantially. Compensation
of the new manager is a flat salary plus 50% of first $200,000
of profit, and then 5% of profit over $200,000. Purchase price for the
company is set as 41
2 times net earnings (profit), computed as average
annual profitability (prior to calculation of the managers bonus) over
the next five years.
(a) Does the bonus structure for the manager provide the manager
with the appropriate incentive to increase profits beyond the first
$200,000 ? Explain briefly.
(b) Is it a good idea to link the purhcase price of the company to the
earnings (profit) of the company. Given this linkage, what do you
think the manager will try to do?
(c) Does this contract align the incentives of the new manager with
the (current)goals of the owners?
Explanation / Answer
Answer a)
The bonus structure of the manager will definitely work to increase sales of the firm as his incentive is attached to the final sales. As the sales increases, 5% of it will be increased in terms of the incentive amount.
Answer b)
The purchase price of the company has been kept at too high. 412 time of earning capacity is too much to purchase the company by this manager. This can not be bought solely with the incentives of the manager. The manager knows his earning capacity and the cost of Purchase of the company, he will not opt to buy this company. He may work on to get the maximum profits in terms of incentives and will drop the idea to buy this company because of its high purchase cost.
Answer c)
The owner's goal is the sell the company to this manager he has hired in order to increase his sales. The manager may work for his incentives and will increase the sales of the company. But he may not opt to buy this company due to high purchasing cost which will not fulfil the owner’s aim of hiring this manager.
Particulars $ Assumed profit 5000000 50% of first 200000 100000 5% of Profit 250000 incentive in 5 Years 1250000 412 time of earning profits (Purchase Cost) 2060000000Related Questions
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