XYZ INC has several divisions and the one managed by Dr. Donaldson has asset base of $4 million and earnings after taxes is $2 million. A new project would earn $2 million per year on an investment of $3 million. If the new project is on, Mr. Donaldson's bonus should not be based on:
A) EVA.
B) ROA.
C) Sales.
D) Accounting profits.
E) Cash flows.

Question

Quizplus · Accepted Answer

ROA (Return on Assets) would decrease with the new project because the project's earnings relative to its asset base ($2 million earnings on $3 million investment) are lower than the current division's performance ($2 million earnings on $4 million asset base). Therefore, basing Mr. Donaldson's bonus on ROA might discourage him from undertaking the new project, even if it could be beneficial for the company overall.

XYZ INC Has Several Divisions and the One Managed by Dr