Question

An organization's managerial decision-making model for capital budgeting is based on the net present value of discounted cash flows. The same organization's managerial performance evaluation model is based on annual divisional return on investment. Which of the following is true?

A. Divisional managers are likely to maximize the measures in the decision-making model.
B. Divisional managers are likely to maximize the measures in the performance evaluation model.
C. The manager has an incentive to accept a project with a positive net present value that initially has a negative effect on net income.
D. The use of models with different criteria promotes goal congruence.

Answer 1

The manager has an incentive to accept a project with a positive net present value that initially has a negative effect on net income. Option C is correct.

Step-by-step explanation:

The correct answer to the given statement is option C. The manager has an incentive to accept a project with a positive net present value that initially has a negative effect on net income. In capital budgeting, the net present value (NPV) is used to assess whether a project is viable or not. A positive NPV indicates that the project is expected to generate more cash inflows than outflows, and therefore increase net income over the long term, even if it initially has a negative effect.

On the other hand, the performance evaluation model based on the annual divisional return on investment (ROI) focuses on short-term profitability. Divisional managers would have an incentive to maximize measures in this performance evaluation model, as it assesses their division's profitability in the current year. However, it may not align with the long-term goals of the organization.

The use of models with different criteria, in this case, promotes goal congruence, as it considers both long-term viability through NPV and short-term profitability through ROI, encouraging managers to make decisions that benefit both.