Pittman Company is a small but growing manufacturer of telecommunications equipm
ID: 2414447 • Letter: P
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 18% 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 $19,600,000 Sales Manufacturing expenses 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 (40%) Net income $7,800,000 2,820,000 10,620,000 8,980,000 3,528,000 240,000* 2.400,000 6,168,000 2,812,000 660,000 2,152,000 860,800 $1,291,200 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, 18% 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 23%." "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 23% 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. at?" "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 aps "We've already worked them up," said Barbara. "Several companies we know about pay a 7.6% 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 $3,528,000 per year, but that would be more than offset by the S4 ,508,000 (23% x $19,600,000) that we would avoid on agents' commissions. The breakdown of the $3,528,000 cost follows: Salaries Sales manager Salespersons Travel and entertainment $ 220,000 1,200,000 880,000 1.228,000 $ 3,528,000 TotalExplanation / Answer
Answer 1. BEP (In $) = Fixed Cost / Contribution Margin Ratio Agents' Commission - 18% Agents' Commission - 23% Own Sales Force 7.6% Comm. Sales 19,600,000.00 19,600,000.00 19,600,000.00 Variable Costs Variable Manufacturing Expenses 7,800,000.00 7,800,000.00 7,800,000.00 Commission to agents 3,528,000.00 4,508,000.00 1,489,600.00 Total Variable Costs 11,328,000.00 12,308,000.00 9,289,600.00 Contribution 8,272,000.00 7,292,000.00 10,310,400.00 Fixed Costs Fixed Manufacturing Expenses 2,820,000.00 2,820,000.00 2,820,000.00 Fixed Marketing Expenses 240,000.00 240,000.00 3,768,000.00 Fixed Administration Expenses 2,400,000.00 2,400,000.00 2,265,000.00 Interest Cost 660,000.00 660,000.00 660,000.00 Total Fixed Costs 6,120,000.00 6,120,000.00 9,513,000.00 Net Operating Income 2,152,000.00 1,172,000.00 797,400.00 Contribution Margin Ratio 42.20% 37.20% 52.60% BEP (In $) 14,500,967 16,449,808 18,084,148 Answer 2. BEP (With Target Profit) = ($6,120,000 + 2,152,000) /37.20 BEP (With Target Profit) = $22,234,119.58 or say $22,234,120 (Approx.) Answer 3. Let the sales = x Therefore, x - (37.20% x + $6,120,000 ) = x - (47.50% x + 9,513,000) 62.80%- $6,120,000 = 47.40% x - 9,513 x = $22,032,467.53 or say $22,032,468 (Approx.) Answer 4. Operating Leverage = Contribution Margin / Income Before Taxes Agents' Commission - 15% Agents' Commission - 20% Own Sales Force Contribution 8,272,000.00 7,292,000.00 10,310,400.00 Net income before Taxes 2,152,000.00 1,172,000.00 797,400.00 Operating Leverage 3.84 6.22 12.93