Background Woodhaven Service is a small, independent filling station located in the Woodhaven section of Queens. The station has three gasoline pumps and two service bays. The repair facility specializes in automotive maintenance (oil changes, tune-ups, etc.) and minor repairs (mufflers, shock absorbers, etc.). Woodhaven generally refers customers who require major work such as transmission rebuilds and electronics to shops that are better equipped to handle such repairs. Major repairs are done in-house only when both the customer and mechanic agree that this is the best course of action. During the 20 years that he has owned Woodhaven Service, Harold Mateen’s competence and fairness have built a loyal customer base of neighborhood residents. In fact, demand for his services has been more than he can reasonably meet, yet the repair end of his business is not especially profitable. Most of his competitors earn the lion’s share of their profits through repairs, but Harold is making almost all of his money by selling gasoline. If he could make more money on repairs, Woodhaven would be the most successful service station in the area. Harold believes that Woodhaven’s weakness in repair profitability is due to the inefficiency of his mechanics, who are paid the industry average of $500 per week. While Harold does not think he overpays them, he feels he is not getting his money’s worth. Harold’s son, Andrew, is a student at the university, where he has learned the Socratic dictum, “To know the Good is to do the Good.” Andrew provided his father with a classic text on employee morality, Dr. Weisbrotten’s Work Hard and Follow the Righteous Way. Every morning for two months, Harold, Andrew, and the mechanics devoted one hour to studying this text. Despite many lively and fascinating discussions on the rights and responsibilities of the employee, productivity did not improve one bit. Harold figured he would just have to go out and hire harderworking mechanics. The failure of the Weisbrotten method did not surprise Lisa, Harold’s daughter. She knew that Andrew’s methods were bunk. As anyone serious about business knows, the true science of productivity and management of human resources resides in Professor von Drekken’s masterful Modifying Organizational Behavior through Employee Commitment. Yes, employee commitment was the answer to everything! Harold followed the scientific methods to the letter. Yet, despite giving out gold stars, blowing up balloons, and wearing a smiley face button, he found Lisa’s approach no more successful than Andrew’s. Compensation Plans Harold thinks that his neighbor Jack Myers, owner of Honest Jack’s Pre-Enjoyed Autorama, might be helpful. After all, one does not become as successful as Jack without a lot of practical knowledge. Or maybe it is Jack’s great radio jingle that does it. Jack tells Harold, It’s not the jingle, you idiot! It’s the way I pay my guys. Your mechanics make $500 a week no matter what. Why should they put out for you? Because of those stupid buttons? My guys—my guys get paid straight commission and nothing more. They do good by me and I do good by them. Otherwise, let ’em starve. Look, it’s real simple. Pay ’em a percent of the sales for the work they do. If you need to be a nice guy about it, make that percent so that if sales are average, then they make their usual $500. But if sales are better, they get that percent extra. This way they don’t get hurt but got real reason to help you out. This hurt Harold. He really liked those buttons. Still, Jack did have a point. Straight commission, however, seemed a little radical. What if sales were bad for a week? That would hurt the mechanics. Harold figured that it would be better to pay each mechanic a guaranteed $300 a week plus a commission rate that would, given an average volume of business, pay them the extra $200 that would bring their wage back to $500. Under this system, the mechanics would be insulated from a bad week, would not be penalized for an average week, and would still have the incentive to attempt to improve sales. Yes, this seemed more fair. On the other hand, maybe Jack knows only about the used car business, not about business in general. Harold figured that he should look for an incentive pay method more in line with the way things are done in the auto repair business. Perhaps he should pay his mechanics as he is paid by his customers—by the job. It is standard practice for service stations to charge customers a flat rate for the labor associated with any job. The number of labor hours for which the customer is charged is generally taken from a manual that outlines expected labor times for specific jobs on specific vehicles. The customer pays for these expected hours regardless of how many actual labor hours are expended on the job. Many shops also pay their mechanics by the job. Harold thinks that this approach makes sense because it links the mechanic’s pay to the labor charges paid by the customer. Required: a. This case presents some popular approaches to alleviating agency costs. Although certain aspects of each of these methods are consistent with the views presented in the text, none of these methods is likely to succeed. Discuss the similarities and differences between the ideas of the chapter and (i) Dr. Weisbrotten’s approach. (ii) Harold Mateen’s idea of hiring “harder-working” mechanics. b. Discuss the expected general effect on agency costs at Woodhaven Service of the new incentive compensation plans. How might they help Woodhaven? Assuming that Harold wants his business to be successful for a long time to come, what major divergent behaviors would be expected under the new compensation proposals? How damaging would you expect these new behaviors to be to a business such as Woodhaven Service? Also, present a defense of the following propositions: (i) Harold’s plan offers less incentive for divergent behavior than Honest Jack’s. (ii) Limiting a mechanic’s pay by placing an upper bound of $750 per week on his or her earnings reduces the incentive for divergent behavior. c. Suppose Harold owned a large auto repair franchise located in a department store in popular suburban shopping mall. Suppose also that this department store is a heavily promoted, well-known national chain that is famous for its good values and easy credit. How should Harold’s thinking on incentive compensation change? What if Harold did not own the franchise but was only the manager of a company-owned outlet? d. In this problem, it is assumed that knowledge and decision rights are linked. The mechanic who services the car decides what services are warranted. Discuss the costs and benefits of this fact for Woodhaven Service and the independently owned chain-store repair shop. e. Suppose that Woodhaven’s problems are not due to agency costs. Briefly describe a likely problem that is apparent from the background description in this problem.
> Brehm Vineyards grows a unique white pinot noir grape that they use to produce a white wine that is in high demand. Brehm uses all the grapes they can grow to produce their own white pinot noir wine. Brehm pinot noir wine contains 100 percent Brehm-grown
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> R&D Inc. has the following financial data for the current year (millions): Earnings before R&D expenditures……………………………………. $21.5 Interest expense……………………………….………………………………. $0.0 R&D expenditures…………………………….………………………………. $6.0 Total invested capital (excl
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> Logical Solutions reports the following overhead variances for 2010: Spending variance …………………………………$100,000 F Efficiency variance …………………………………$100,000 F Volume variance …………………………………..$300,000 F In addition, actual overhead incurred in 2010 was $1 mill
> Repro Corporation is the leading manufacturer and seller of office equipment. Its most profitable business segment is the production and sale of large copiers. The company is currently organized into two divisions: manufacturing and sales. Manufacturing
> The Ogden plant makes Beanie Babies, small stuffed toys in a variety of animal shapes. The toys are so popular that they have become collectors’ items. The plant uses a flexible budget and predetermined overhead rates to assign overhead costs to the diff
> Geico is considering expanding an existing plant on a piece of land it already owns. The land was purchased 15 years ago for $325,000 and its current market appraisal is $820,000. A capital budgeting analysis shows that the plant expansion has a net pres
> You work for the strategy group of Adapt Inc., a firm that designs and manufactures memory cards for digital cameras. Your task is to gather intelligence about Adapt’s key competitor, DigiMem, a privately held company. Your boss has asked you to estimate
> Rothwell Inc. is the leader in computer-integrated manufacturing and factory automation products and services. The Rothwell product offering is segmented into 15 product categories, based on product function and primary manufacturing location. Rothwell’s
> Sunder manufactures hard rubber pet toys. The purple dog chewy has a variable cost of $3.00 per unit. It is produced on a machine that is leased. The three models of this machine have three different capacities. Maximum Daily Daily Lease Capacity (Units)
> Eastern Educational Services is considering the following proposal to sell its teaching machine and purchase a new, improved machine. The following data are presented by the department head: Additional information: 1. The company expects to produce 10,00
> JLE Electronics is an independent contract manufacturer of complex printed circuit board assemblies. Computer companies and other electronics firms engage JLE to assemble their boards. Utilizing computer-controlled manufacturing and test machinery and eq
> Salespeople at a particular firm forecast what they expect to sell next period. Their supervisors then review the forecasts and make revisions. These forecasts are used to set production and purchasing plans. In addition, salespeople receive a fixed bonu
> The Mopart Division produces a single product. Its standard cost system uses a flexible budget to assign indirect costs on the basis of standard direct labor hours. At the budgeted volume of 4,000 direct labor hours, the standard cost per unit is as foll
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> Kitchen Rite is considering outsourcing the production of a steel chassis that is used in a kitchen appliance. Two thousand chassis are produced per month. An outside vendor will supply an identical chassis for $9.90. The chassis is manufactured in two s
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> Employees at White’s Department Store are observed engaging in the following behavior: (1) They hide items that are on sale from the customers and (2) they fail to expend appropriate effort in designing merchandise displays. They are also uncooperative w
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> Secure Servers Inc. (SSI) is one of the largest software and service providers directed at providing high levels of backup and security for computer servers to the financial community, military, and other clients requiring off-site backup and security sy
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> Phonetex is a medium-size manufacturer of telephone sets and switching equipment. Its primary business is government contracts, especially defense contracts, which are very profitable. The company has two plants: Southern and Westbury. The larger plant,
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> Measer Enterprises produces standardized telephone keypads and operates in a highly competitive market in which the keypads are sold for $4.50 each. Because of the nature of the production technology, the firm can produce only between 10,000 and 13,000 u
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> Karsten Mills is one of the premier carpet manufacturers in the world. It manufactures carpeting for both residential and commercial applications. Home sales and commercial sales each account for about 50 percent of total revenue. The firm is organized i
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> Magnetic resonance imaging (MRI) is a noninvasive medical diagnostic device that uses magnets and radio waves to produce a picture of an area under investigation inside the body. A patient is positioned in the MRI and a series of images of the area (say,
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> The city of Toledo has received a proposal to build a new multipurpose outdoor sports stadium. The expected life of the stadium is 20 years. It will be financed by a 20-year bond paying 8 percent interest annually. The stadium’s primary tenant will be th
> CJ Equity Partners is a privately held firm that buys small family-owned firms, installs professional managers to run the firms, and then sells them 3–5 years later, often for a substantial profit. CJ Equity is owned by four partners wh
> Wine Distributors is a wholesaler of wine, buying from wineries and selling to wine stores. Three different white wines are sold: Chablis, Chardonnay, and Riesling. Here are budgeted and actual sales data for the month of April. Required: Write a short m
> a. What is the difference between budget lapsing and line-item budgets? b. What types of organizations would you expect to use budget lapsing? c. What types of organizations would you expect to use line-item budgets?
> Winter Games manufactures a competitive line of skis and sells its skis to retailers at a price of $225 per pair. Based on an annual volume of 5,000 pairs, the cost per pair is $185: Sports Palace, a discount sporting goods store, currently purchases 500
> Employee bonuses at American InterConnect (AI), a large communications firm, depend on meeting a number of targets, one of which is a revenue target. Some bonus is awarded to the group if it meets or exceeds its target revenue for the year. The bonus is
> Using your knowledge of the relationship between inflation and nominal interest rates, and assuming that the savings were invested in government bills, comment briefly on the analysis presented in the following letter from the National Taxpayers Union: D
> Allied Adhesives (AA) manufactures specialty bonding agents for very specialized applications (electronic circuit boards, aerospace, health care, etc.). AA operates a number of small plants around the world, each one specializing in particular products f
> Home Auto Parts is a large retail auto parts store selling the full range of auto parts and supplies for do-it-yourself auto repair enthusiasts. The store is arranged with three prime displays in the store: front door, checkout counters, and ends of aisl
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> Jan Vanderschmidt was the founder of a successful chain of restaurants located throughout Europe. He died unexpectedly last week at the age of 55. Jan was sole owner of the company’s common stock and was known for being very authoritarian. He made most o
> Tagway 4000 is a computer manufacturer based in Montana. One component of the computer is an internal battery that keeps track of the time and date while the computer is turned off. Tagway produces the batteries in-house. The division that produces the b
> Betterton Corporation manufactures automobile headlight lenses and uses a standard cost system. At the beginning of the year, the following standards were established per 100 lenses (a single batch). Expected volume per month is 5,000 direct labor hours
> Ed Koehler started Great Southern Furniture five years ago to assemble prefabricated bedroom furniture for large hotel chains. Hotels purchase furniture (beds, night stands, and chests of drawers) from manufacturers who ship the furniture to the hotels u
> You work in the Strategy Analysis department of On-Call, a worldwide paging firm offering satellite based digital communications through sophisticated pagers. On-Call is analyzing the possibility of acquiring AtlantiCom, an East Coast paging firm in Main
> Amy Laura is opening a snowboard rental store. She rents snowboards for skiing on a weekly basis for $75 per week including the boots. The skiing season is 20 weeks long. Laura can buy a snowboard and boots for $550, rent them for a season, and sell them
> PortCo Products is a divisionalized furniture manufacturer. The divisions are autonomous segments, each responsible for its own sales, costs of operations, working capital management, and equipment acquisition. Each division serves a different market in
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> Coase Farm grows soybeans near property owned by Taggart Railroad. Taggart can build zero, one, or two railroad tracks adjacent to Coase Farm, yielding a net present value of $0, $9 million, or $12 million. Value of Taggart Railroad
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