The following forecast variable costing income statement was prepared for Electric Machines Ltd. for the year ending April 2013:
Sales............... $100,000,000
Variable costs........... 45,000,000
Contribution margin........ 55,000,000
Fixed costs........... 25,000,000
Net income........... 30,000,000
The general manager is interested in buying a leisure boat with a tag price of $30,000 with the bonus he will collect in May 2013 (based on the net income of the year ending in April 2013). To estimate his bonus, he developed a probabilistic model for a range of possible outcomes for these financial parameters. He collected the following information from various managers within the firm:
i. The likelihood that the worst-case scenario for sales would occur (drop of 25%) was set at
15%. The likelihood that the best-case scenario for sales would occur (an increase of 25%) was set at 10%. Finally, the likelihood that the most likely scenario would occur (sales of $100,000,000) was set at 75%.
ii. The likelihood that the worst-case scenario for fixed costs would occur (increase of 20%) was set at 20%. The likelihood that the best-case scenario for fixed costs would occur (a decrease of 20%) was set at 20%. Finally, the likelihood that the most likely scenario would occur (fixed costs of $25,000,000) was set at 60%.
iii.Variable costs will always run at 45% of sales.
The general manager’s compensation is composed of a flat salary of $75,000 plus 1% of net income that is in excess of the target for the year. The target for the year ending April 2013 was $26,500,000.
REQUIRED
1. Calculate the expected outcome and determine if the manager will be able to buy the boat with the bonus he will collect in May 2013.
2. Suppose the owners of Electric Machines propose to change the remuneration to the general manager and they offer a flat salary of $100,000. Explain why the general manager would be interested in accepting the offer or not. What is more convenient in the long term for the general manager?