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: Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales $ 24,000,000 Manufacturing expenses: Variable $ 10,800,000 Fixed overhead 3,360,000 14,160,000 Gross margin 9,840,000 Selling and administrative expenses: Commissions to agents 3,600,000 Fixed marketing expenses 168,000 * Fixed administrative expenses 2,120,000 5,888,000 Net operating income 3,952,000 Fixed interest expenses 840,000 Income before income taxes 3,112,000 Income taxes (30%) 933,600 Net income $ 2,178,400 *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 $3,600,000 per year, but that would be more than offset by the $4,800,000 (20% × $24,000,000) that we would avoid on agents’ commissions.” The breakdown of the $3,600,000 cost follows: Salaries: Sales manager $ 150,000 Salespersons 900,000 Travel and entertainment 600,000 Advertising 1,950,000 Total $ 3,600,000 “Super,” replied Karl. “And I noticed that the $3,600,000 equals what we’re paying the agents under the old 15% commission rate.” “It’s even better than that,” explained Barbara. “We can actually save $110,400 a year because that’s what we’re paying our auditors 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.” Required: 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 decides to continue selling through agents and pays the 20% commission rate. Determine the dollar sales that would be required to generate the same net income as contained in the budgeted income statement for next year. 3. Determine the dollar sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 20% commission rate) or employs its own sales force. 4. Compute the degree of operating leverage that the company would expect to have at the end of 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. Use income before income taxes in your operating leverage computation.

Please Please give me the right answers put them as simple as posible

Answer 1

		Budgeted income statement for different alternatives:
				15% commission		20% commission		Own sales force
	Sales (a)			24000000	100%	24000000	100%	24000000	100%
	Variable expenses:
	Manufacturing			10800000		10800000		10800000
	Commissions			3600000		4800000		1800000
						(24000000*20%)		(24000000*7.5%)
	Total variable expenses (b)			14400000	60.00%	15600000	65.00%	12600000	52.50%
	Contribution margin ©=(a)-(b)			9600000	40.00%	8400000	35.00%	11400000	47.50%
	Fixed expenses:
	Manufacturing overhead			3360000		3360000		3360000
	Marketing			168000		168000		3768000	*
								(168000+3600000)
	Administrative			2120000		2120000		2009600	**
								(2120000-110400)
	Interest			840000		840000		840000
	Total fixed expenses (d)			6488000		6488000		9977600
	Income before income taxes €=©-(d)			3112000		1912000		1422400
	Less: Taxes @ 30%			933600		573600		426720
	Net income			2178400		1338400		995680
	* Additional fixed expense of $3600000 added in Marketing expenses
	** Savings in audit fees reduced from administrative cost
1	Breakeven point in $=Fixed expenses/Contribution margin %
a.	Breakeven point in $=6488000/40%=$ 16220000
b.	Breakeven point in $=6488000/35%=$ 18537143
c.	Breakeven point in $=9977600/47.50%=$ 21005474
2	Required net income before taxes=$ 2178400
	Sales required to attain the target=(Required net income before taxes+Fixed expenses)/Contribution margin %=(2178400+6488000)/35%=$ 24761143
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=0.65x+6488000
	Total expenses under own sales force=0.525x+9977600
	0.65x+6488000=0.525x+9977600
	(0.65-0.525)x=9977600-6488000
	x=6489600/0.125=$ 51916800
4	Degree of operating leverage=Contribution margin/Income before taxes
a.	Degree of operating leverage=9600000/3112000=3.08
b.	Degree of operating leverage=8400000/1912000=4.39
c.	Degree of operating leverage=11400000/1422400=8.01