Question

3-48 Choosing between compensation plans, operating leverage. CMA, adapted) AgroPharm Corporation manufactures pharmaceutical products that are sold through a network of external sales agents. The agents are paid a commission of 18% of revenues. AgroPharm is considering replacing the sales agents with its own salespeople, who would be paid a commission of 12% of revenues and total salaries of $7,950,000. The income statement for the year ending December 31, 2017, under the two scenarios is shown here. | 4 Home Insert Page Layout Formulas Data Review View В C D E 1 | AgroPharm Corporation Income Statement 3 For the Year Ended December 31, 2017 Using Sales Agents Using Own Sales Force 5 Revenues $45,000,000 $45,000,000 6 Cost of goods sold 71 Variable $15,750,000 $15,750,000 8 Fixed 5.425,000 21.175.000 5.425.000 21.175.000 9 Gross margin $23,825,000 $23,825,000 10 Marketing costs 11] Commissions $ 8,100,000 $ 5,400,000 12 Fixed costs 5.250,000 13.350.000 7.950,000 13,350,000 13 Operating income $10.475.000 $10.475.000 Required: 1. Calculate AgroPharm's 2017 contribution margin percentage, breakeven revenues, and degree of operating leverage under the two scenarios. 2. Describe the advantages and disadvantages of each type of sales alternative. 3. In 2018, AgroPharm uses its own salespeople, who demand a 14% commission. If all other cost-behavior patterns are unchanged, how much revenue must the salespeople generate in order to earn the same operating income as in 2017?

Answer 1

1.

Solution :

Variable cost under external sales agents scenario = $15750000 + $8100000 = $23850000

Variable cost under own agents scenario = $15750000 + $5400000 = $21150000

Fixed cost under external sales agents = $5425000 + $5250000 = $10675000

Fixed cost under own agents scenario = $5425000 + $7950000 = $12200000

Contribution margin percentage = (sales - variable cost) /sales

Using sales agents :

Contribution margin percentage = ($45000000 - $23850000)/$45000000

= $19350000/$45000000

= 0.43

That means 43%

Break even revenue = fixed cost /contribution margin percentage

= $10675000/43%

=$24825582

Operating leverage = contribution margin /operating income

= $19350000/$10475000

= 1.8472

Using own agents:

Contribution margin percentage = ($45000000 - $21150000)/$45000000

= $23850000/$45000000

= 0.53

That means 53%

Break even revenue = $12200000/53% = $23018868

Operating leverage = $23850000/$10475000 = 2.1975

2.

Using sales agents :

Advantage - as it has less fixed cost compared to the other, risk of the corporation is less.

Disadvantage - as contribution margin is less compared to other, in case of high sales it results in less operating income compared to other scenario.

Using own agents :

Advatange - as it has more contribution margin compared to the other scenario, in case of high sales it results in more profit.

Disadvantage - as it has more fixed cost, risk of the corporation is more. That means, in case of low sales the financial obligation on company increases.

3)

New commission = $6300000*

New variable cost = $15750000 + $6300000 = $22050000

New contribution margin percentage = ($45000000 - $22050000)/$45000000

=0.51

Required sales = $12200000/51% = $23921568

* New commission = ($5400000×14%)/12% = $6300000