Question:
Manhattan Electronics Corporation produces a variety of computer products. Recently the firm has revealed plans to expand into new office automation products. To realize the expansion plans, the firm will need to go to the stock market for additional capital in October of this year. Present plans call for raising $200,000,000 in new common equity. Historically, the firm's small notebook computer has been a significant contributor to corporate profits. However, a competitor has recently introduced a notebook model that has rendered Manhattan Electronic's notebook computer obsolete. At some point, the controller has informed the president, the inventory of notebooks needs to be "written down" to realizable value. Because Manhattan Electronics has a large inventory of the notebooks on hand, the write-down will have a very detrimental effect on both the balance sheet and income statement. The president, whose compensation is determined in part by corporate profits and in part by stock price, has suggested that the write-downs be deferred until the next fiscal year (next January). He argues that, by deferring the write-down, existing shareholders will realize more value from the shares to be sold in October because the stock market will not be informed of the pending write-downs.
a. What effects are the performance evaluation measures of the president likely to have on his decision to defer the write-down of the obsolete inventory?
b. Is the president's decision to defer the write-down of the inventory an ethical treatment of existing shareholders? Of potential new shareholders?
c. If you were the controller of Manhattan Electronics, how would you respond to the president's decision to defer the write-down until after issuance of the new stock?