Question

Magnolia Manufacturing makes wing components for large aircraft. Kevin Choi is the production manager, responsible for manufacturing, and Michelle Michaels is the marketing manager. Both managers are paid a flat salary and are eligible for a bonus. The bonus is equal to 1 percent of their base salary for every 10 percent profit that exceeds a target. The maximum bonus is 5 percent of salary. Kevin’s base salary is $260,000 and Michelle’s is $320,000.

The target profit for this year is $8 million. Kevin has read about a new manufacturing technique that would increase annual profit by 20 percent. He is unsure whether to employ the new technique this year, wait, or not employ it at all. Using the new technique will not affect the target.

Required:

a. Suppose that profit without using the technique this year will be $8 million. By how much will Kevin’s and Michelle’s bonus change if Kevin decides to employ the new technique?

b. Suppose that profit without using the technique this year will be $10.5 million. By how much will Kevin’s and Michelle’s bonus change if Kevin decides to employ the new technique?

Answer 1

a) Target profit = $8 Million

As Kevin decides to employ new technique, profit will increase by 20%, So,

Profit = $8 Million + ($8 Million * 20%) = $ 8 Million + $ 1.6 Million = $9.6 Million

1% Bonus for every 10% change in target Profit. (20% / 10 = 2%)

Kevin Bonus will change by 2%= $260,000 * 2% = $5,200

Michelle Bonus will change by 2% = $320,000 * 2% = $6,400

b) Profit = $10.5 Million

Profit Increase $2.5 Million ($10.5 Million - $8 Million)

% Bonus = 3%

Bonus W/O Tech Bonus W / Tech Bonus Change

Kevin $5,200 $7,800 (3% of Basic Salary) $2,600

Michelle $6,400 $9,600 (3% of Basic salary) $3,200