lncenti.ves and Decision Making HS Custom W oodshop (HSCW) specializes in custom cabinet work. HSCW uses many different types of machines, which are repaired and replaced at regular intervals in order to ensure low-cost, high-quality operations.

The factory manager, Nero Oakie, recently authorized the purchase of an $85,000 automated lathe that will be used to make spindles for stairways. This machine has just been installed. At the projected level of operations, this machine is expected to last for 10 years and have annual operating costs of $40,000. The machine is assumed to be worthless at the end of its life.

Nero is concerned about a recent development. Susie Company has just announced the availability of a new machine that performs the same tasks as the machine just installed at HSCW. The Susie machine would cost $ 130,000, last for 10 years, and have annual operating costs of $35,000. This Susie machine will provide for improved quality .

that Nero expects will increase operating margins by $10,000 a year over and above the operating cost savings. The machine just installed has a value, net of salvage, of $50,000.

The new machine would have no salvage value in 10 years.

Nero is currently paid a salary of $60,000 and receives a bonus of one-half of one percent of corporate net income. Nero estimates that he will remain with HSCW for

"about two more years." At that time he expects to achieve a promotion and raise by moving to another company.

In the questions that follow, ignore income taxes and assume that HSCW's pre-tax required return is 12%. The company uses the straight-line method to compute depreciation.

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Required (1) Should the company keep the newly installed machine on buy the Susie machine? (2) Which machine would Nero prefer? (3) What motivation problems are caused by using short-run financial measures of perfor- mance as reward devices? (4) How might the inconsistencies raised in Requirements 1 and 2 and the problems raised in 3 be mitigated?