Alexis Lynn is the sole shareholder of Lynn Imaging, which manufactures a variety of medical imaging devices. In early 2016, Lynn hired a new CEO, Paul Stang, who is paid an annual salary of $200,000 plus a bonus of $50,000 if the increase in net income relative to the prior year is greater than 5%.
Dividend policy at Lynn Imaging has been to pay cash dividends on December 31 of each year equal to net income for the year. Stang convinced Lynn that rather than pay dividends of $871,000 at the end of 2016, Lynn Imaging should instead use the cash to acquire Bridger Inc., a small competitor. The acquisition was completed on January 1, 2017.
The weighted average cost of capital (WACC) for Lynn Imaging is 12%. (Lynn Imaging has no interest-bearing debt, so the cost of capital is the cost of equity capital.)
Assume there are no income taxes. Because there are no income taxes and no interest-bearing debt, Net Income = Operating Income = NOPAT.
Balance Sheet: 2016 2017
Assets:
Cash & Accounts Receivable 200,000 300,000
Inventory 500,000 800,000
Goodwill -0- 371,000
Factory and Equipment, Net 4,500,000 4,300,000
Land 1,000,000 1,000,000
Total Assets 6,200,000 6,771,000
Liabilities:
Accounts Payable 600,000 500,000
Wages Payable 600,000 400,000
Shareholder's Equity
Common Stock 5,000,000 5,000,000
Retained Earnings -0- 871,000
Total Liabilities + Equity 6,200,000 6,771,000
Lynn Imaging's operating income in 2017 equaled $923,000. The company had R&D expense (used to develop new imaging technologies) of $200,000 in 2015, $300,000 in 2016 and $0 in 2017 and $0 (estimated) in 2018. For EVA purposes, Lynn believes that R&D provides benefits over 2 years and therefore should be amortized in equal amounts over a 2-year useful life, starting in the year of the expenditure.
-Did Stang meet the requirements to earn a bonus of $50,000 in 2017?