Q1)Westside Plumbing and Heating Company is oï¬ered a contract for $100,000 to provide plumbing for a new building. The labor and equipment costs are calculated to be $60,000 for fulï¬lling the contract. Westside has materials in its inventory to complete the job. The raw materials initially cost the ï¬rm $50,000; however the material prices have declined in the interim and now cost only $37,500. Thus if the ï¬rm chose not to accept the contract and sells the materials, they would incur a loss of $12,500. Material prices are not expected to go up in the future. Should Westside accept the contract. Explain your answer.
Q2) The owners of a small manufacturing concern have hired a manager to run the company with the expectation that (s)he will buy the company after ï¬ve years. The goal of the owners in making this hire is to ï¬nd the appropriate manager that will increase proï¬ts substantially. Compensation of the new manager is a ï¬at salary plus 50% of ï¬rst $200,000 of proï¬t, and then 5% of proï¬t over $200,000. Purchase price for the company is set as 4.5
times net earnings (proï¬t), computed as average annual proï¬tability (prior to calculation of the managers bonus) over the next ï¬ve years.
(a) Does the bonus structure for the manager provide the manager with the appropriate incentive to increase proï¬ts beyond the ï¬rst $200,000 ? Explain brieï¬y.
(b) Is it a good idea to link the purhcase price of the company to the earnings (proï¬t) of the company. Given this linkage, what do you think the manager will try to do?
(c) Does this contract align the incentives of the new manager with the (current)goals of the owners?
Q1)Westside Plumbing and Heating Company is oï¬ered a contract for $100,000 to provide plumbing for a new building. The labor and equipment costs are calculated to be $60,000 for fulï¬lling the contract. Westside has materials in its inventory to complete the job. The raw materials initially cost the ï¬rm $50,000; however the material prices have declined in the interim and now cost only $37,500. Thus if the ï¬rm chose not to accept the contract and sells the materials, they would incur a loss of $12,500. Material prices are not expected to go up in the future. Should Westside accept the contract. Explain your answer.
Q2) The owners of a small manufacturing concern have hired a manager to run the company with the expectation that (s)he will buy the company after ï¬ve years. The goal of the owners in making this hire is to ï¬nd the appropriate manager that will increase proï¬ts substantially. Compensation of the new manager is a ï¬at salary plus 50% of ï¬rst $200,000 of proï¬t, and then 5% of proï¬t over $200,000. Purchase price for the company is set as 4.5
times net earnings (proï¬t), computed as average annual proï¬tability (prior to calculation of the managers bonus) over the next ï¬ve years.
(a) Does the bonus structure for the manager provide the manager with the appropriate incentive to increase proï¬ts beyond the ï¬rst $200,000 ? Explain brieï¬y.
(b) Is it a good idea to link the purhcase price of the company to the earnings (proï¬t) of the company. Given this linkage, what do you think the manager will try to do?
(c) Does this contract align the incentives of the new manager with the (current)goals of the owners?
