Sam Jones is the president of Apollo Finance, a payday lender. The company's proxy statement contains the following description of Mr. Jones' pay package.Mr. Jones is eligible for an annual incentive bonus equal to 1% of Net Income of the company and is eligible for an additional bonus based upon annual increases in EPS only after earnings exceed 15% over the prior year. The additional bonus is determined as follows:EPS Growth Additional BonusEPS increases up to 14.9% $0EPS increases of 15.0% to 24.9% 2% of the earnings increase from the prior yearEPS increases of 25.0% to 34.9% 3% of the earnings increase from the prior yearEPS increases above 35.0% 4% of the earnings increase from the prior yearAssume no change in the number of shares of outstanding stock during the

Question

year.Required:a.  Suppose that Apollo Finance had $75 million of Net Income for the year. How much of a bonus would Mr. Jones receive if the EPS increase for the year was 12%?b.  Suppose that Apollo Finance had $75 million of Net Income for the year. How much of a bonus would Mr. Jones receive if the EPS increase for the year was 28%?

What will be an ideal response?

Answer 1

a. 
According to the bonus formula, Mr. Jones would receive a bonus of $750,000 if the company reports net income of $75 million and the EPS increase is 12 percent.
Basic bonus = 1% of $75 million = $750,000
Additional bonus = zero

b. 
According to the bonus formula, Mr. Jones would receive a bonus of $1,242,188 if the company reports net after-tax earnings of $75 million and the EPS increase is 28 percent.
Basic bonus = 1% of $75 million = $750,000
Additional bonus = 3% of $16,406,250 = $492,188 

Since the company has not issued or repurchased stock during the year, a 28% increase in EPS must also mean that net income increased 28%. In other words, $75 million = (1 + .28) × earnings last year. So, earnings last year must equal $75 million ÷ (1.28) or $58,593,750. The increase in net income would then be $16,406,250 = ($75 million ? $58,593,750).