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ACCA Strategic Professional · Advanced Financial Management · The role and responsibility of senior financial executive/advisor

Kappa Ltd has a bonus scheme paying executives 2% of the increase in earnings per share. The finance director proposes to reduce discretionary R&D spending by 30 million in the final quarter, which will lift this year's EPS by 6% but is expected to cut future cash flows with a present value of 45 million. Which assessment is correct?

The action destroys about 15 million of shareholder value, because the 30 million saving is outweighed by 45 million of lost future cash flows. It reflects short-termism encouraged by an EPS-linked bonus, which the adviser should challenge in favour of long-term value-based rewards.

  1. AThe action is value-enhancing because EPS rises
  2. BThe action is neutral because R&D is discretionary
  3. CThe action destroys shareholder value by 15 million net of the 30 million saved and indicates short-termism driven by a poorly designed reward schemeCorrect
  4. DThe action creates 75 million of value because savings and lost flows add together

Explanation

Saving 30 million reduces future cash flows worth 45 million in present value, so the net effect is 30 - 45 = -15 million of value. The EPS-linked bonus encourages short-termism, which conflicts with the adviser's duty to promote long-term shareholder wealth. Adding the figures (75m) is a sign error.

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