NCL plc, which has a divisionalized structure, undertakes civil engineering and mining activities. All applications by divisional management teams for funds with which to undertake capital projects require the authorization of the board of directors of NCL plc. Once authorization has been granted to a capital application, divisional management teams are allowed to choose the project for investment. Under the terms of the management incentive plan, which is currently in operation, the managers of each division are eligible to receive annual bonus payments which are calculated by reference to the return on investment (ROI) earned during each of the first two years by new investments. ROI is calculated using the average capital employed during the year. NCL plc depreciates its investments on a straight-line basis. One of the most profitable divisions during recent years has been the IOA Division, which is engaged in the mining of precious metals. The management of the IOA Division is currently evaluating three projects relating to the extraction of substance xxx from different areas in its country of operation. The management of the IOA Division has been given approval by the board of directors of NCL plc to spend 24 million on one of the three proposals it is considering (i.e. North, East and South projects). The following net present value (NPV) calculations have been prepared by the management accountant of the IOA Division North Project East Project South Project Net cashflow 000 PV (12%) 000 Net cashflow 000 PV at 12% 000 Net cashflow 000 PV12% 000 Year 0 (24,000.0) (24,000.0) (24,000.0) (24,000.0) (24,000.0) (24,000.0) Year 1 6,000.0 5,358.0 11,500.0 10,269.5 12,000.0 10,716.0 Year 2 8,000.0 6,376.0 11,500.0 9,165.5 10,000.0 7,970.0 Year 3 13,500.0 9,612.0 11,500.0 8,188.0 9,000.0 6,408.0 Year 4 10,500.0 6,678.0 3,000.0 1,908.0 NPV 4,024.0 3,623.0 3,002.0 The following additional information concerning the three projects is available: 1 Each of the above projects has a nil residual value. 2 The life of the East project is three years. The North and South projects are expected to have a life of four years. 3 The three projects have a similar level of risk. 4 Ignore taxation. Required 1 Explain (with relevant calculations) why the interests of the management of the IOA Division might conflict with those of the board of directors of NCL plc. 2 Explain how the adoption of residual income (RI) using the annuity method of depreciation might prove to be a superior basis for the management incentive plan operated by NCL plc. ( Note: No illustrative calculations should be incorporated into your explanation). 3 The IOA Division is also considering whether to undertake an investment in the West of the country (the West Project). An initial cash outlay investment of 12 million will be required and a net cash inflow amounting to 5 million is expected to arise in each of the four years of the life of the project. The activities involved in the West project will cause the local river to become polluted and discoloured due to the discharge of waste substances from mining operations. It is estimated that at the end of year four a cash outlay of 2 million would be required to restore the river to its original colour. This would also clear 90% of the pollution caused as a result of the mining activities of the IOA Division. The remaining 10% of the pollution caused as a result of the mining activities of the IOA Division could be cleared up by a further cash outlay of 2 million. Evaluate the West project and, stating your reasons, comment on whether the board of directors of NCL plc should spend the further 2 million in order to eliminate the remaining 10% of pollution. (Ignore taxation.) ( ACCA Performance Management, adapted)