1. Management Compensation Plan DTH’s goal is to increase its business by at least 10% a year in a very competitive environment. The compensation plan is consistent with this goal because it rewards increases in revenues and new clients. It is likely, however, that under the current plan, each office is focusing only on the client base in its own region. A problem occurs when DTH must make proposals that require joint cooperation and participation among two or more offices. The compensation plan does not have an incentive for cooperation. In fact, it could be a distraction and reduce the potential for a substantial bonus for any given office to develop a proposal for a large contract in which other offices might benefit. The cost of the proposal would be borne by the office, and the benefits would accrue to other offices as well as the originating office. The cost of the proposal for large contracts must therefore be shared among the offices in some way, or any one office will not have the incentive to spend the time and money necessary to develop a large proposal. In addition to sharing the cost of the proposal, DTH should consider having a firmwide proposal development group for these large projects. The individual offices would then be charged for the cost of this group, perhaps in proportion to the fees received from large contracts in that office. Clearly, the firm is losing the larger contracts, and the compensation and proposal development plans must provide the needed incentive for each office to go after them aggressively. Another alternative is to go to a firmwide compensation pool that would provide a direct and strong incentive for each office to cooperate in developing new business. A disadvantage of this approach is that it would reduce the motivation for each office to seek business in its own region because the revenues from these individual efforts would be shared firmwide. Another issue concerning the current compensation plan is the office manager’s discretion to divide the office bonus among the professionals in the office. Although no one has complained, a lower-level professional is unlikely to complain about the office manager’s bonus decisions. The equity of this system should be reviewed to ensure that each office manager is using this discretion in a fair and appropriate way.
2. Business Valuation Because WebSmart is a relatively new company currently showing losses and negative cash flows, the earnings-multiple and discounted cash flow approaches are not suitable. Moreover, because the company is not public, there is no current stock price. This leaves two possibilities: the book value of equity method and the revenues-multiple method. The book value of equity is given at $1,200,000. In contrast, the revenue multiple would estimate value at $4,200,000 = 7 × $600,000. Alternatively, WebSmart could use projected revenues in the multiple calculation. Moreover, it could use projected cash flows in a cash flow multiple or discounted cash flow calculation, since cash flow would presumably be positive in the coming years. Also, the firm has an asset, the Guide to Competitive Colleges, which has a market value of $1,350,000, so any valuation should be higher than that figure. Overall, this is a difficult firm to value; the range from $1,350,000 to $4,200,000 is a very wide range. Also, there is significant uncertainty about future cash flows, which are critical to the overall valuation.