Pittman Company is a small but growing manufacturer of telec

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. The statement follows: Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales S21,400,000 $8,100,000 3,060,000 Variable Fixed overhead Gross margin Selling and administrative expenses: Commissions to agents Fixed marketing expenses Fixed administrative expenses Net operating income Fixed interest expenses Income before income taxes Income taxes (20%) Net income 11,160,000 10,240,000 3,210,000 300,000* 6.210,000 4,030,000 720,000 3,310,000 662,000 S 2,648,000 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 ust 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 1 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 8.2% 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 $3,210,000 per year, but that would be more than offset by the $4,280,000 (20% x $21,400,000) that we would avoid on agents\' commissions. The breakdown of the $3,210,000 cost follows: Salaries: Sales manager Travel and entertainment Total S 280,000 1,500,000 1,120,000 310,000 $3,210,000 \"Super,\" replied Karl. \"And I noticed that the $3,210,000 is just what we\'re paying the agents under the old 15% commission rate.\" \"It\'s even better than that,\" explained Barbara. \"We can actually save $165,000 a year because that\'s what we\'re having to pay the auditing firm now to check out the agents\' reports. So our overall administrative expenses would be less. Pull all of these numbers together and we\'ll show them to the executive committee tomorrow,\" said Karl. \"With the approval of the committee, we can move on the matter immediately.\"

Solution

Budgeted income statement for different alternatives: 15% commission 20% commission Own sales force Sales (a) 21400000 100% 21400000 100% 21400000 100% Variable expenses: Manufacturing 8100000 8100000 8100000 Commissions 3210000 4280000 1754800 (21400000*20%) (21400000*8.2%) Total variable expenses (b) 11310000 52.85% 12380000 57.85% 9854800 46.05% Contribution margin ©=(a)-(b) 10090000 47.15% 9020000 42.15% 11545200 53.95% Fixed expenses: Manufacturing overhead 3060000 3060000 3060000 Marketing 300000 300000 3510000 (300000+3210000) Administrative 2700000 2700000 2535000 (2700000-165000) Interest 720000 720000 720000 Total fixed expenses (d) 6780000 6780000 9825000 Income before income taxes €=©-(d) 3310000 2240000 1720200 Less: Taxes @ 20% 662000 448000 344040 Net income 2648000 1792000 1376160 1 Breakeven point in $=Fixed expenses/Contribution margin % a. Breakeven point in $=6780000/47.15%=$ 14379639 b. Breakeven point in $=6780000/42.15%=$ 16085409 c. Breakeven point in $=9825000/53.95%=$ 18211307 2 Required net income before taxes=$ 3310000 Sales required to attain the target=(Required net income before taxes+Fixed expenses)/Contribution margin %=(3310000+6780000)/42.15%=$ 23938316 3 We need to make the net income equal under both alternatives.Hence.Total expenses under both alternatives would be same Assume x=Total sales revenue Total expenses under 20 % commission=0.5785x+6780000 Total expenses under own sales force=0.4605x+9825000 0.5785x+6780000=0.4605x+9825000 (0.5785-0.4605)x=9825000-6780000 x=3045000/0.118=$ 25805085 4 Degree of operating leverage=Contribution margin/Income before taxes a. Degree of operating leverage=10090000/3310000=3.05 b. Degree of operating leverage=9020000/2240000=4.03 c. Degree of operating leverage=11545200/1720200=6.71