2019. Sisters Inc., is now a worldwide pet food conglomerate, run by two sisters, Big Sister, the CEO, and Little Sister, the President. As a result of a massive “we are the 100% minus 1% strike,” that attracted national media attention, the company started negotiating a new union agreement with its employee union, “Pets R. US” effective January 1, 2019, and as the new union representative, Guy W.G. Shepherd is responsible for determining how the agreement will impact the company’s overhead, especially its defined benefit pension plan.
Moreover, Guy needs to decide if the agreement is fair and whether Sisters Inc. is not “lowballing” and can really afford to provide a higher pension expense to its employees and avoid future labor strikes.
As a threshold for “lowballing,” the union agreed that pension expense should be at least 1% of Sister’s budgeted net income for 2020, based on what other pension plans are offering and the theme of the last labor strike. Therefore, if the pension expense is greater than 1% of budgeted net income, Guy W.G. Shepherd is prepared to accept Sisters’ proposal on behalf of “Pets R Us.” If it is less than 1%, it’s back to the drawing board for further negotiations.
At first, Sisters Inc. wanted to delay the negotiations and give W.G. Shepherd some pumpkin and chicken (his favorite meal) and even offered to invite him to his favorite ball game, but W.G. Shepherd refused since he didn’t want that to influence his decision-making ability as a steward and representative of the union.
After a late night of negotiations Sisters’ CEO Big Sister finally gave W.G. Shepherd something real to chew on. Sisters Inc. proposed a new defined pension plan called the “Meow Max Plan” that creates a defined benefit plan for employees who are expected to retire in six years at the end of 2025 since those were the employees who were most active in the recent strike.
Mew Max Pension Plan Details and Assumptions
Start of Plan
1 Jan. 2019
Pension Plan Benefit Payments
Expected retirement date
31 Dec. 2025
Annual payments are paid at year end and continue for 30 years, 100 employees are expected to retire in 2025. At this time, Sisters Inc. has made no plans to provide any contributions to the plan, but may decide to do so in a few years.
Average Salary from last 5 years:
Estimated years in retirement
Budgeted Net Income for 2020: $150 million
Benefit Formula: Average of Last 5 Years’ Salary × Number of Years of Service × 0.025 What is the estimated retirement payment one employee will earn at the end of year after they retire as part of the Mew Max Plan? (Hint: Use benefit formula) – $7,000 $7,500 $8,000 $8,500
2. What is the present value of estimated future retirement payments at the start of retirement for one employee? (Hint: Use the amount calculated above as your annuity payment and the given assumptions above for the number of years and discount rate) $85,505
3. What is the average undiscounted service cost earned by employees each year? (Hint: Divide the amount you calculated above by the number of years of service) $15,024 $18,029
What is the discounted service cost component of the Meow Mix Pension Plan at the end of 2019 for just one employee (Hint: calculate the present value of the amount calculated above) $13,176 $13,900 $15,811 $16,680
What is the projected benefit obligation at the end of 2019? (Hint: include all employees covered by the plan) $1,317,600 $1,390,000 $1,581,100 $1,668,000
What is the service cost at the end of 2020 assuming just one employee was in the plan? $13,900 $14,665 $15,811 $17,598
What is the interest cost at the end of 2020? $50,000 $76,450 $85,961 $91,740
What is pension expense at the end of 2020? 1,390,000 1,466,500 1,543,060 1,545,625
What is the projected benefit obligation at the end of 2020? 1,390,000 1,543,060 2,856,500 2,933,060
Should W.G. Shepherd accept Big Sister’s proposal? Yes No