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ACCA Strategic Professional · Advanced Financial Management · Strategic business and financial planning for multinational organisations

Zentra Inc's board proposes a project with an expected NPV of $4.0m, but it would cause the group's reported earnings per share to fall in the first two years. Managers' bonuses are based on EPS. Which advice from the senior financial adviser best reflects the adviser's role?

The adviser should recommend accepting the project because a positive NPV increases shareholder wealth, while tackling the agency problem by redesigning rewards toward long-term value and communicating clearly to investors. Rejecting it for short-term EPS or hiding the effect would conflict with wealth maximisation and ethics.

  1. AReject the project, because short-term EPS is the main determinant of share price
  2. BAccept the project on NPV grounds and recommend revising the reward scheme and communicating the long-term value to investors, to reduce the goal conflictCorrect
  3. CAccept the project but conceal the EPS effect from managers to prevent resistance
  4. DDefer the decision until EPS would rise in the first year under any project

Explanation

Positive NPV indicates an increase in shareholder wealth, which is the primary objective. The adviser should address the agency conflict created by EPS-based rewards, for example by aligning rewards to long-term value and managing investor communication. Rejection ignores wealth maximisation, and concealment is unethical.

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