EZPAK Manufacturing produces filament packaging tape. In 2010, EZPAK Manufacturing produced and sold 15 million rolls of tape. The company has recently expanded its capacity, so it can now produce up to 30 million rolls per year. EZPAK Manufacturing’s accounting records show the following results from 2010:
Sales price per roll.............................................................................. $ 3.00
Variable manufacturing expenses per roll.......................................... $ 2.00
Variable marketing and administrative expenses per roll.................. $ 0.50
Total fixed manufacturing overhead costs......................................... $8,400,000
Total fixed marketing and administrative expenses........................... $ 600,000
Sales............................................................................................. 15 million rolls
Production.................................................................................... 15 million rolls
There were no beginning or ending inventories in 2010.
In January 2011, EZPAK Manufacturing hired a new president, Kevin McDaniel. McDaniel has a one-year contract specifying that he will be paid 10% of EZPAK Manufacturing’s 2011 operating income (based on traditional absorption costing) instead of a salary. In 2011, McDaniel must make two major decisions:
1. Should EZPAK Manufacturing undertake a major advertising campaign? This campaign would raise sales to 25 million rolls. This is the maximum level of sales that EZPAK Manufacturing can expect to make in the near future. The ad campaign would add an additional $3.5 million in marketing and administrative costs. Without the campaign, sales will be 15 million rolls.
2. How many rolls of tape will EZPAK Manufacturing produce? At the end of the year, EZPAK Manufacturing’s board of directors will evaluate McDaniel’s performance and decide whether to offer him a contract for the following year.
Requirements
Within your group form two subgroups. One subgroup assumes the role of Kevin McDaniel,
EZPAK Manufacturing’s new president; the other subgroup assumes the role of EZPAK Manufacturing’s board of directors. McDaniel will meet with the board of directors shortly after the end of 2011 to decide whether he will remain at EZPAK Manufacturing. Most of your effort should be devoted to advance preparation for this meeting. Each subgroup should meet separately to prepare for the meeting between the board and McDaniel. (Hint:Keep computations [other than per-unit amounts] in millions.)
Kevin McDaniel should do the following:
1. Compute EZPAK Manufacturing’s 2010 operating income.
2. Decide whether to adopt the advertising campaign by calculating the projected increase in operating income from the advertising campaign. Do not include the executive bonus in this calculation. Prepare a memo to the board of directors explaining this decision. Use the fol- lowing format:
Date:
To:
From:
Subject:
Give this memo to the board of directors as soon as possible (before the joint meeting).
3. Assume that EZPAK Manufacturing adopts the advertising campaign. Decide how many rolls of tape to produce in 2011. Assume that no safety stock is considered necessary to EZPAK’s business.
4. Given your response to Question 3, prepare an absorption costing income statement for the year ended December 31, 2011, ending with operating income before bonus. Then, compute your bonus separately. The variable cost per unit and the total fixed expenses (with the exception of the advertising campaign) remain the same as in 2010. Give this income statement and your bonus computation to the board of directors as soon as possible (before your meeting with the board).
5. Decide whether you want to remain at EZPAK Manufacturing for another year. You currently have an offer from another company. The contract with the other company is identical to the one you currently have with EZPAK Manufacturing—you will be paid 10% of absorption costing operating income instead of a salary.
The board of directors should do the following:
1. Compute EZPAK Manufacturing’s 2010 operating income.
2. Determine whether EZPAK Manufacturing should adopt the advertising campaign by calculating the projected increase in operating income from the advertising campaign. Do not include the executive bonus in this calculation.
3. Determine how many rolls of tape EZPAK Manufacturing should produce in 2011. Assume that no safety stock is considered necessary to EZPAK’s business.
4. Evaluate McDaniel’s performance based on his decisions and the information he provided to the board. (Hint:You may want to prepare a variable costing income statement.)
5. Evaluate the contract’s bonus provision. Are you satisfied with this provision? If so, explain why. If not, recommend how it should be changed. After McDaniel has given the board his memo and income statement and after the board has had a chance to evaluate McDaniel’s performance, McDaniel and the board should meet. The purpose of the meeting is to decide whether it is in everyone’s mutual interest for McDaniel to remain with EZPAK Manufacturing and, if so, the terms of the contract EZPAK Manufacturing will offer McDaniel.