The following scenario relates to questions 26 to 30.
The following information relates to an investment project which is being evaluated by the directors of Fence Co, a listed company. The initial investment, payable at the start of the first year of operation, is $3.9 million.
What is the payback period of the investment project?
Payback period = 2 + (1,200/1,600) = 2.75 years
Based on the average investment method, what is the return on capital employed of the investment project?
Average annual accounting profit = (5,880 – 3,800)/4 = $520,000 per year
Average investment = (3,900 + 100)/2 = $2,000,000
ROCE = 100 x 520/2,000 = 26%
Which of the following statements about investment appraisal methods is correct?
Payback period ignores the timing of cash flows within the payback period is correct.
Which of the following statements about Fence Co is/are correct?
(1) Managerial reward schemes of listed companies should encourage the achievement of stakeholder objectives
(2) Requiring investment projects to be evaluated with return on capital employed is an example of dysfunctional behaviour encouraged by performance-related pay
(3) Fence Co has an agency problem as the directors are not acting to maximise the wealth of shareholders
All the statements are correct.
Which of the following statements about Fence Co directors’ remuneration package is/are correct?
(1) Directors’ remuneration should be determined by senior executive directors
(2) Introducing a share option scheme would help bring directors’ objectives in line with shareholders’ objectives
(3) Linking financial rewards to a target return on capital employed will encourage short-term profitability and discourage capital investment
Introducing a share option scheme would help bring directors’ objectives in line with shareholders’ objectives and linking financial rewards to a target return on capital employed will encourage short-term profitability and discourage capital investment are correct.