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- Pittman company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own; rather, it relies completely on independent sales agents to markets its products. These agents are paid a sales commission of 15% for all items sold. Barbara Cheney, Pittman’s controller, has just prepared the company’s budgeted income statement for next year. The statement follows:
- Sales……………………………………$16,000,000
- Manufacturing expenses:
- variable………………..$7,200,000
- fixed overhead………..2,340,000………..$9,540,000
- Gross Margin………………………………….6,460,000
- Selling and Admin expenses
- commissions to agents…2,400,000
- fixed marketing expenses..120,00
- Fixed admin expenses……..1,800,000……4,320,000
- Net operating income…………………………2,140,000
- Fixed interest expenses……………………….540,000
- Income before income taxes………………….1,600,000
- incomes taxes (30%)…………………………..480,000
- Net income……………………………………….1,120,000
- This statement was made using agents 15% commission rate, but next year will increase to 20%. Several companies they know about pay a 7.5% commission to their own salespeople, along with a small salary. Of course, they have to handle promotional cost, too. They figure their fixed expenses would increase by $2,400,000 per year, but that would be more than offset by the $3,200,000 (20% X $16,000,000) that they would avoid on agents’ commissions.
- The break down of the $2,400,000 cost follows:
- Salaries
- Sales manager………………..$100,000
- Salespersons…………………..600,000
- Travel and entertainment……..400,000
- Advertising……………………….1,300,000
- Total………………………………..$2,400,000
- They save $75,000 a year because that’s what they are having to pay the auditing firm now to check out the agents’ reports. So administration expenses would be less.
- 1.) Compute pittman company’s break-even point in dollar sales for next year assuming:
- a. the agents’ commission rate remains unchanged at 15%
- b. the agents’ commission rate is increased to 20%.
- c. the company employs its own sales force
- 2.) assume that pittman company decided to continue selling through agents and pays the 20% commission rate. Determine the volume of sales that would be required to generate the same net income as contained in the budgeted income statement for next year.
- 3.)Determine the volume of sales at which net income would be equal regardless of whether pittman company sells through agents (at 20% commission rate) or employs its own sales force.
- 4.) Compute the degree of operating leverage that the company would expect to have on December 31 at the end of next year assuming:
- a. the agents’ commission rate remains unchanged at 15%
- b. the agents’ commission rate is increased at 20%
- c. the company employs its own sales force
- -use income BEFORE income taxes in your operating leverage computation
- 5.) Based on the data in (1) through (4) above, make a recommendation as to whether the company should continue to use sales agents (at 20% commission rate) or employ its own sales force. Give reasons for your answer
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