Thomas Owan is a division manager of Weat-farl Inc. He is in the process of evaluating a $ 4,000,000 investment. The following net annual increases, before depreciation, in divisional income are expected during the investment’s five-year life:
Year 1 ....... $ 300,000
Year 2 ....... 500,000
Year 3 ....... 760,000
Year 4 ....... 3,200,000
Year 5 ....... 2,900,000
All company assets are depreciated using the straight-line method. Owan receives an annual salary of $ 300,000 plus a bonus of 2 percent of divisional pre-tax profits. Before consideration of the potential investment project, he anticipates that his division will generate $ 4,000,000 annually in pre-tax profit.
a. Compute the effect of the new investment on the level of divisional pre-tax profits for years 1 through 5.
b. Determine the effect of the new project on Owan’s compensation for each of the five years.
c. Based on your computations in (b), will Owan want to invest in the new project? Explain.
d. Would upper management likely view the new investment favorably? Explain.