The Medford Mug Company is an old-line maker of ceramic coffee mugs. It imprints company logos and other sayings on mugs for both commercial and wholesale markets. The firm has the capacity to produce 50 million mugs per year, but the recession has cut production and sales in the current year to 15 million mugs. The accompanying table shows the operating statement for 2016.


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Income Statement

Year Ending 2016 ($ in Millions)

Sales (15 million @ $2)                                                                                                                 $ 30.0

Less costs of goods sold

Variable cost (15 million @ $0.50)                                      (7.5)

Fixed cost                                                                                   (20.0)                                             (27.5)

Gross margin                                                                                                                                      $ 2.5 

Less selling and administration                                                                                                      (4.0)

Operating profit                                                                                                                                $ (1.5)

At the end of 2016, there was no ending inventory of finished goods. The board of directors is very concerned about the $1.5 million operating loss. It hires an outside consultant who reports back that the firm suffers from two problems. First, the president of the company receives a fixed salary, and because she owns no stock, she has very little incentive to worry about company profits. The second problem is that the company has not aggressively marketed its product and has not kept up with changing markets. The current president is 64, and the board of directors makes her an offer to retire one year early so that they can hire a new president to turn the firm around. The current president accepts the offer to retire, and the board immediately hires a new president with a proven track record as a turnaround specialist. The new president is hired with an employment contract that pays a fixed wage of $50,000 a year plus 15 percent of the firm’s operating profits (if any). Operating profits are calculated using absorption costing. In 2017, the new president doubles the selling and administration budget to $8 million (which includes the president’s salary of $50,000). He designs a new line of “politically correct” sayings to imprint on the mugs and expands inventory and the number of distributors handling the mugs. Production is increased to 45 million mugs, and sales climb to 18 million mugs at $2 each. Variable costs per mug remain at $.50 and fixed costs at $20 million in 2017. At the end of 2017, the president meets with the board of directors and announces he has accepted another job. He believes he has successfully gotten Medford Mug back on track and thanks the board for giving him the opportunity. His new job is helping to turn around another struggling company.


a. Calculate the president’s bonus for 2017.

b. Evaluate the performance of the new president in 2017. Did he do as good a job as the numbers in part (a) suggest?

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