Exam 3 - Practice Problems.pdf

# Paul has been at consul for a long time but has

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Paul has been at Consul for a long time, but has failed to earn a promotion. His annual salary is \$78,000. His performance was determined to be below average. John’s salary is \$69,000. His relative performance evaluation score rated him as above average. 0% 1% 3% 1% 3% 5% 2% 5% 7%

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Exam 3 – Practice Problems Page 54 Required: 1. (3 points) Following the merit increase matrix, what will Peter, Paul, and John’s salaries be for the upcoming year? Peter’s expected salary \$ Paul’s expected salary John’s expected salary 2. (2 points) What is the overall percentage increase in the salaries to be paid to junior consultants, relative to the salaries that they are currently earning? Salaries are expected to increase by % \$ \$
Exam 3 – Practice Problems Page 55 SOLUTION: 1. (3 points) Following the merit increase matrix, what will Peter, Paul, and John’s salaries be for the upcoming year? Peter’s expected salary = 60,000 x (1 + 0.07) = 64,200 Paul’s expected salary = 78,000 John’s expected salary = 69,000 x (1 + 0.05) = 75,600 2. (2 points) What is the overall increase in salaries to junior consultants, relative to the current year? (4,200 + 3,340)/ (60,000 + 78,000 + 72,000) = 3.696 %

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Exam 3 – Practice Problems Page 56 PROBLEM: Viper Squad is a U. S. based international conglomerate comprised of a number of geographically differentiated investment centers. Keel Bill is the manager of the South American division, an investment center which markets a diverse group of products and services, including wedding planning, steel welding, and assassinations. Employing assets with a net book value of \$20,000,000, the South American division’s current operations generate net earning (income) of \$5,000,000, annually. Mr. Bill believes that the division can achieve identical results in the future provided that it maintains its current operations and periodically replaces used assets. Viper Squad’s cost of capital, r , is = 10%. In order to align the private interests of the division managers with those of the shareholders, Viper Squad employs an incentive compensation scheme which pays each manager a bonus based on the divisions’s annual return on investment (ROI). The firm measures ROI for year t as the ratio of divisional operating income ( I t ) to divisional Net Assets at the beginning of the year ( NA t -1 ). The operating income is computed as the difference between the net operating cash flow ( CF t ) and the periodic depreciation ( d t ) : Return on Investment for period t: ROI t = Operating Income for period t: I t = CF t - d t And, a manager’s annual bonus is determined as: Bonus t = Base Salary × ROI t Keel Bill is considering whether to implement either or both of the two investment projects described below: Year 2013 2014 2015 2016 Investment \$9,000,000 -- -- -- Project 1 Net Operating Cash Flow -- \$5,250,000 \$5,400,000 \$3,000,000 Investment \$6,000,000 -- -- -- Project 2 Net Operating Cash Flow -- \$3,200,000 \$2,800,000 \$2,400,000 The (initial) investment is to be made on January 1, 2013. Net operating cash flows will be realized at the end of the year. The initial investment is to be depreciated using the straight-line method and an estimated residual (salvage) value of zero. Depreciation will begin in 2014.
Exam 3 – Practice Problems Page 57 Required: 1. (3 points) What is the Net Present Value of the cash flows for each project?

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