The owners of a small manufacturing concern have hired a manger to run the company with the expectation that he will buy the company after five years. Compensation of the new Vice President is a flat salary plus 75% of the first $150,000 profit, then 10% of profit over $150,000. Purchase price for the company is set at 4.5 times earnings (profit), computed as average annual profitability over the next five years.

A. Assume the company will be worth $10million in five years. Plot the profit of buying the company as a function of annual profit.

B. Does this contract align the incentives of the new vice president with the profitability goals of the owners?

C. Re-design the contract to better align the incentives of the new vice president with the profitability goals of the owners.