Based on your experience at the business School, you were just appointed to the compensation committee of the board of directors for Buggy Corp. Suppose that Buggy Corp. earned income of $30 million during the most recent year and has a book value of $500 million. Its cost of capital is 7%.
a. What is the net ROI for Buggy Corp.?
b. What is the residual income for Buggy Corp.?
c. Based on the net ROI and residual income, how would you evaluate the performance of Buggy Corp. during the most recent year?
d. You are considering two new compensation plans for the CEO of Buggy Corp. The first plan is a conventional stock-option plan, with the exercise price fixed at today's stock price. The second plan is a stock-option plan, with the exercise price based on a portfolio of Buggy Corp.'s competitors. The exercise price for the second plan is set such that it is only valuable to the CEO if the stock of Buggy Corp. performs better than its competitors. What are the pros and cons of each compensation plan?