Pepin Lamps

Pepin Lamps manufactures various types of lamps and lighting fixtures. Pepin’s products range from small desk lamps to large-scale fluorescent lighting tubes for industrial use. One of Pepin’s products is a ceiling chandelier decorated with fine crystal. These chandeliers sell for $2,000 each. Pepin sells approximately 800 of these crystal chandeliers every year, which represents just 10% of Pepin’s total sales revenue. Due to the high costs of producing this product line, Pepin is considering discontinuing the crystal chandelier.

Direct materials are $900 per chandelier. Direct labor is $500 per chandelier. Because the chandeliers are fragile, Pepin must use special packing materials and higher cost methods of shipping to deliver the crystal chandeliers to customers. These packing and shipping costs total $200 per chandelier. Because the chandeliers are too fragile to be stored in the factory, completed chandeliers are stored in an off-site storage facility until they are shipped to customers. Pepin rents a special storage facility, used only for the chandeliers, on a one-year renewable lease at a cost of $27,000 per year. Pepin spends $35,000 annually to advertise the chandelier product line and pays a 6% sales commission for each chandelier sold. In the most recent fiscal year, the following costs were allocated to the crystal chandelier product line: general fixed manufacturing overhead of $58,000, depreciation of $155,000, and general and administrative expenses of $80,000. If the crystal chandeliers are dropped, Pepin will not be able to reduce general fixed manufacturing overhead costs, or depreciation costs, or general and administrative costs.

The chandelier production process is complex and requires a separate line supervisor, Brett Everett, whose salary is $60,000 per year. Brett reports to the other factory supervisor, Darren Lohmann, who is the general factory supervisor and oversees production of all products in the factory. Darren’s annual salary is $90,000 and because crystal chandeliers represent 10% of total revenue, 10% of Darren’s salary is allocated to chandeliers. If the crystal chandeliers are dropped, Darren Lohmann’s salary will not be changed and he will continue with all his previous supervisory duties. However, Brett Everett will no longer be needed and his job will be completely eliminated.

1. Compute the operating income for the chandelier product line after all costs, including the allocated costs described above, if Pepin sells 800 crystal chandeliers. Explain why Pepin is thinking about dropping the product line.

2. Would you advise Pepin to discontinue its crystal chandelier product line? Calculate how much higher (or lower) Pepin’s profit would be if the chandelier product line was dropped. Show and clearly label your supporting calculations.

Vern’s of Vermont
Vern’s of Vermont manufactures toothpaste. Production and sales data for the past year are as follows:
• Each case of toothpaste sells for $118.
• Planned production: 2,900 cases of toothpaste.
• Actual production: 3,000 cases of toothpaste.
• Direct materials: Purchased and used, 3,400 gallons at $17.30 per gallon; standard price is $18.00 per gallon. Standard quantity allowed per case produced is 1 gallon.
• Direct labor: Standard allowed per case produced is 1.25 hours. Standard price per direct-labor hour is $38.00. Actual costs, 3,925 hours at $38.60, or $151,505.
• Variable manufacturing overhead: Actual costs, $46,675. Budget formula is $11.00 per standard direct-labor hour.
• Fixed manufacturing overhead: Budgeted cost, $95,000. Actual costs, $100,000. Fixed overhead is allocated based on units of output.
Prepare an analysis to address the following questions:
1. a) What is budgeted profit at the original 2,900 case planned level of production?
b) What is budgeted profit at the actual 3,000 case level of production?
c) What was actual profit? (3 pts each for parts a, b, and c)
The CEO, Vern Thomas, is struggling to understand why actual profit was lower than the original budgeted profit, even though the actual level of production was higher than the original budgeted level of production.
Prepare a variance analysis that explains the components of the difference between the original budgeted profit and the actual profit. Show clearly what amount of the overall difference is due to each of the components in questions 2 and 3. Label each variance as favorable (F) or unfavorable (U):
2. What was the budgeted effect on profit of operating at a higher level of activity than planned, i.e., selling 3,000 cases rather than 2,900 cases?
3. What was the effect of spending an amount different than budgeted to produce 3,000 cases for each of the following costs of production:
a) materials
b) direct labor
c) variable overhead
d) fixed overhead

4. Vern noted that the actual costs and quantities of materials and labor were different than budgeted. Calculate variances to separate the effects of
a) the difference between the actual labor wage rate of $38.60/hour versus the standard labor wage rate of $38.00/hour at the actual 3,000-case level of production
b) the difference between actual labor hours of 3,925 hours versus the standard hours for the actual 3,000-case level of production
c) the difference between actual material cost of $17.30/gallon versus the budgeted materials costs of $18.00/gallon to produce 3,000 cases
d) the difference between actual material use of 3,400 gallons versus the budgeted materials use for the actual 3,000-case level of production

Kendall Company

In late 2013, the Board of Directors of Kendall Company concluded it was time to make a change and hired a new CEO. Since the management change, Kendall Company has had steady growth in profitability as shown in the summary results below. Net income increased each year between 2014 and 2016, and increased by about 25% in total over the three-year span. Largely because of the steady increases in net income, the Board of Directors has been awarding generous bonuses to the new CEO.
2013, 2014, 2015, 2016
Current Assets 1,500 1,600 1,750 2,000
Non-Current Assets 7,500 9,500 12,500 15,000
Total Assets 9,000 11,100 14,250 17,000

Current Liabilities 1,000 1,000 1,000 1,000
Long-term Debt 500 1,550 3,593 5,179
Common stock 6,000 6,000 6,000 6,000
Retained Earnings 1,500 2,550 3,657 4,821
Total Liabilities and OE 9,000 11,100 14,250 17,000

Revenue 8,000 9,800 12,300 14,300
Operating Expenses -6,200 -7,800 -10,000 -11,600
Operating Income 1,800 2,000 2,300 2,700
Interest Expense -50 -155 -359 -518
Tax Expense -700 -738 -776 -873
Net Income 1,050 1,107 1,164 1,309

Kendall’s current liabilities consist entirely of non-interest bearing liabilities.
At the time the new CEO was hired in 2013, Kendall changed from a dividend policy that pays out cash dividends equal to earnings each year to a policy where all earnings are retained in the business. By retaining all earnings instead of distributing them as dividends and also steadily increasing long-term debt, Kendall has been able to finance substantial growth in total assets of about 89% over the three-year span.
The interest rate on all long-term debt is 10% and Kendall’s corporate tax rate is 40%. Kendall’s weighted average cost of capital (WACC) has remained steady at 12% across all four years, even as the mix of debt and equity in the capital structure has changed over time.
Despite steady increases in net income, the stock price has declined slowly but steadily from $50 per share in 2013 when the new CEO was hired to $38 per share near the end of 2016. The Board of Directors has become increasingly uncomfortable about the fact that they have provided large bonuses to management while stock price has been declining.

1. Compute EVA for each of the years: 2013, 2014, 2015, and 2016. For purposes of this calculation you can assume there are no adjustments to Operating Income or Total Assets needed for “Bad GAAP”.
2. Using your calculations from item 1, write a brief memo (no more than 2 paragraphs) advising the Board on the performance of senior management during the last three years.

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