Question

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 market 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 as follows: $18,500,000 10,915,000 7,585,000 Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales Manufacturing expenses: Variable $8,325,000 Fixed overhead 2,590,000 Gross margin Selling and administrative expenses: Commissions to agents 2,775,000 Fixed marketing expenses 129,500* Fixed administrative expenses 1,900,000 Net operating income Fixed interest expenses Income before income taxes Income taxes (30%) Net income 4,804,500 2,780,500 647,500 2,133,000 639,900 $ 1,493,100 *Primarily depreciation on storage facilities. As Barbara handed the statement to Karl Vecci, Pittman's president, she commented, "I went ahead and used the agents' 15% commission rate in completing these statements, but we've just learned that they refuse to handle our products next year unless we increase the commission rate to 20%." "That's the last straw," Karl replied angrily. "Those agents have been demanding more and more, and this time they've gone too far. How can they possibly defend a 20% commission rate?" "They claim that after paying for advertising, travel, and the other costs of promotion, there's nothing left over for profit," replied Barbara. "I say it's just plain robbery," retorted Karl. "And I also say it's time we dumped those guys and got our own sales force. Can you get your people to work up some cost figures for us to look at?" "We've already worked them up," said Barbara. "Several companies we know about pay a 7.5% commission to their own salespeople, along with a small salary. Of course, we would have to handle all promotion costs, too. We figure our fixed expenses would increase by $2,775,000 per year, but that would be more than offset by the $3,700,000 (20% * $18,500,000) that we would avoid on agents' commissions."

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Answer 1

1a) BEP in dollar sales = Fixed expenses/CM ratio (5267000/40%) 13,167,500 15% Commission 18,500,000 100.0% 20% Commission 18,500,000 Own Sales Force 18,500,000 100.0% 100.0% working: Sales Variable expenses: Manufacturing Commissions (15%, 20%, 7.5%) Total variable expenses 1b) BEP in dollar sales = Fixed expenses/CM ratio (5267000/35%) 15,048,571 8,325,000 2,775,000 11,100,000 8,325,000 3,700,000 12,025,000 8,325,000 1,387,500 9,712,500 60.0% 65.0% 52.5% 1c) Contribution margin 7,400,000 40.0% 6,475,000 35.0% 8,787,500 47.5% 16,751,368 BEP in dollar sales = Fixed expenses/CM ratio (7956900/47.5%) | 21,142,857 volume of sales = (Target income before tax + fixed expense)/CM ratio (2133000+5267000)/35% Fixed expenses: Manufacturing overhead Marketing Administrative Interest Total fixed expenses 2,590,000 129,500 1,900,000 647,500 5,267,000 2,590,000 129,500 1,900,000 647,500 5,267,000 2,590,000 2,904,500 1,814,900 647,500 7,956,900 Income before income taxes Income taxes (30%) 2,133,000 639,900 1,208,000 362,400 830,600 249,180 3) let the total revenue be 'a' 0.65a+5267000=0.525a+7956900 0.125a=2689900 a=21519200. Net income 1,493,100 845,600 581,420 - 129500+2775000 1900000-85100 Sheet267 Sheet268 Sheet269 Sheet270 Sheet271 Sheet272 Sheet273 Sheet274 Sheet275 - ENG US 17:36 11/02/2020

15%. Commission 2016 Commission Own Salesforce 4) 15% Commission 20% Commission Own Sales Force Contribution margin (A) Income before taxes (B) Degree of operating leverage: (A) +(B) 7,400,000 2,133,000 3.47 6,475,000 1,208,000 5.36 8,787,500 830, 600 10.58