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: $ 20,000,000 11,800,000 8,200,000 Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales Manufacturing expenses: Variable $ 9,000,000 Fixed overhead 2,800,000 Gross margin Selling and administrative expenses: Commissions to agents 3,000,000 Fixed marketing expenses 140,000* Fixed administrative expenses 1,960,000 Net operating income Fixed interest expenses Income before income taxes Income taxes (30%) Net income 5,100,000 3,100,000 700,000 2,400,000 720,000 1,680,000 $ *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.

Answer 1

a.	Break-even point in dollar sales						14,000,000
	BEP(dollar sales) =		fixed expense/contribution margin ratio
			Fixed cost				5,600,000
			Contribution margin				40.0%
b)	Break even point in dollar sales						16,000,000
c)	Break even point in dollar sales						17,911,579
2)	Voulme of sales (in dollars)						22,857,143
	(Target income before taxes +fixed expense)/contribution margin
3)	Voulme of Sales (in dollars)						23,264,000
	X =	total evenue
	.65 X + 5,600,000=		.525x +8,508,000
		0.125	x	=		2,908,000
			x =	23264000
4)
a)	Degree of operating leverage						3.33
b)	Degree of operating leverage						5.00
c)	Degree of operating leverage						9.58
	degree of operating leverage = contribution marging/income before taxes

			15% comm		20% comm		7.5% comm
Sales			20,000,000	100%	20,000,000	100%	20,000,000	100%
Variable expenses:
manufacturing			9,000,000		9,000,000		9,000,000
comissions (15%;20%,7.5%)			3,000,000		4000000		1500000
total variable expense			12,000,000	60.0%	13,000,000	65.0%	10,500,000	52.5%
contribution margin			8,000,000	40.0%	7,000,000	35.0%	9,500,000	47.5%
fixed expenses
manufacturing overhead			2,800,000		2,800,000		2,800,000
marketing			140,000		140,000		3,140,000
administrative			1,960,000		1,960,000		1,868,000
interest			700,000		700,000		700,000
total fixed expense			5,600,000		5,600,000		8,508,000
income before income taxes			2,400,000		1,400,000		992,000
income taxes (30%)			720000		420000		297600
net income			1,680,000		980,000		694,400
increase in fixed expense-marketing							3,000,000
saving in administrative expense							-92000