North Sea Drilling Company is an oil and gas exploration and drilling company operating off the coast of Scotland. Oil and gas companies inevitably incur costs on unsuccessful exploration ventures called dry holes. A debate continues over whether those costs should be written off as period expenses or capitalized as part of the full cost of finding profitable oil and gas ventures. Management has been writing these costs off to expense as incurred. However, this year a new management team was hired to improve the profit picture of the firm’s Oil and Gas Exploration Division with the provision that it would receive a bonus equal to 10 percent of any profits in excess of the division’s base-year profits. However, no bonus would be paid if profits were less than 20 percent of end-of-year investment. The following information was included in the division’s performance report.

Increase over Base Year This Year Base Year SaIESMEVCMUC was tian eer ceraccn eyR artrn Maantaaasredtitsab s $4,000,000 $4,100,000 Costs incurred:

Diidioleseies 4. eee nent italy sary wns tert ped ohs 800,000 )

Depreciation and other amortization... 750,000 780,000 OUACTECOSISHRE fee et halen creek A Ea 1,550,000 1,600,000 DiVISIOMDFOllL ate eee er eet ete teee nea eee eee cee $ 900,000 $1,720,000 $820,000 End-of-year INVESTMENT ........ccccccceetsecseeeteeecteeeneeenns $6,900,000 $8, 100,000*

*Includes other investments not at issue here.

During the year, the new team spent $1 million on exploratory activities, of which $900,000 was for unsuccessful ventures. The new management team has included the $900,000 in the current end-ofyear investment base because, it states, “You can’t find the good ones without hitting a few bad ones.”

Required

a. What is the ROI for the base year and the current year?

b. What is the amount of the bonus that the new management team is likely to claim?

c. If you were on North Sea Drilling Company’s board of directors, how would you respond to the new management’s claim for the bonus?