Pittman Company is a small but growing manufacturer of telecommunications equipm
ID: 2602456 • 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 14% for all items sold.
Barbara Cheney, Pittman’s controller, has just prepared the company’s budgeted income statement for next year. The statement follows:
As Barbara handed the statement to Karl Vecci, Pittman’s president, she commented, “I went ahead and used the agents’ 14% 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 19%.”
“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 19% 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 8.1% 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 $2,954,000 per year, but that would be more than offset by the $4,009,000 (19% × $21,100,000) that we would avoid on agents’ commissions.”
“Super,” replied Karl. “And I noticed that the $2,954,000 is just what we’re paying the agents under the old 14% commission rate.”
“It’s even better than that,” explained Barbara. “We can actually save $160,000 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 costs 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.”
Compute Pittman Company’s break-even point in dollar sales for next year assuming: (Enter your answer in whole dollars and not in thousands. Round CM ratio to 3 decimal places and final answer to the nearest dollar amount.)
The agents’ commission rate remains unchanged at 14%.
Break even point in dolar sales ??
The agents’ commission rate is increased to 19%.
Break even point in dolar sales ???
The company employs its own sales force.
Assume that Pittman Company decides to continue selling through agents and pays the 19% commission rate. Determine the volume of sales that would be required to generate the same net income as contained in the budgeted income statement for next year. (Enter your answer in whole dollars and not in thousands. Round CM ratio to 3 decimal places.)
Volume of sales in dolar ???
Determine the volume of sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 19% commission rate) or employs its own sales force. (Enter your answer in whole dollars and not in thousands. Round CM ratio to 3 decimal places.)
Volume of sales in dolar ?
Compute the degree of operating leverage that the company would expect to have on December 31 at the end of next year assuming:
The agents’ commission rate remains unchanged at 14%. (Round your answer to 2 decimal places.)
Degree of operating leverage ???
The agents’ commission rate is increased to 19%. (Round your answer to 2 decimal places.)
Degree of operating leverage ???
The company employs its own sales force. (Round your answer to 2 decimal places.)
Degree of operating leverage ???
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 14% for all items sold.
Barbara Cheney, Pittman’s controller, has just prepared the company’s budgeted income statement for next year. The statement follows:
Explanation / Answer
1) a) Sales 21100000 100.000% Variable expenses: Manufacturing 8050000 38.152% Sales commission (14%) 2954000 14.000% Total variable expenses 11004000 52.152% Contribution margin 10096000 47.848% Fixed expenses: Manufacturing overhead 3020000 Marketing 290000 Administrative 2650000 Interest 710000 Total fixed expenses 6670000 Income before income taxes 3426000 Income tax (40%) 1370400 Net Income 2055600 BREAK EVEN POINT IN DOLLAR SALES = Fixed Expenses/Contribution margin ratio. Fixed expenses 6670000 CM Ratio 47.848% BEP in Dollar Sales 13939976.6 Answer b) Sales 21100000 100.000% Variable expenses: Manufacturing 8050000 38.152% Sales commission (19%) 4009000 19.000% Total variable expenses 12059000 57.152% Contribution margin 9041000 42.848% Fixed expenses: Manufacturing overhead 3020000 Marketing 290000 Administrative 2650000 Interest 710000 Total fixed expenses 6670000 Income before income taxes 2371000 Income tax (40%) 948400 Net Income 1422600 BREAK EVEN POINT IN DOLLAR SALES = Fixed Expenses/Contribution margin ratio. Fixed expenses 6670000 CM Ratio 42.848% BEP in Dollar Sales 15566654.2 Answer c) Sales 21100000 100.000% Variable expenses: Manufacturing 8050000 38.152% Sales commission (8.1%) 1709100 8.100% Total variable expenses 9759100 46.252% Contribution margin 11340900 53.748% Fixed expenses: Manufacturing overhead 3020000 Marketing (290000+2954000) 3244000 Administrative (2650000-160000) 2490000 Interest 710000 Total fixed expenses 9464000 Income before income taxes 1876900 Income tax (40%) 750760 Net Income 1126140 BREAK EVEN POINT IN DOLLAR SALES = Fixed Expenses/Contribution margin ratio. Fixed expenses 9464000 CM Ratio 53.748% BEP in Dollar Sales 17608097 Answer 2) Sales required to earn a net income of $2,055,600 = Sales required to earn EBT of $3,426,000 Contribution required = Required EBT + Fixed expenses = 3426000+6670000 = $10,096,000 Required sales = Required contribution/CM ratio = 10096000/42.848% = $23,562,360 CHECK: Sales 23562360 111.670% Variable expenses: Manufacturing 8989431.18 38.152% Sales commission (19%) 4476848 19.000% Total variable expenses 13466279.6 63.821% Contribution margin 10096080.4 47.849% Fixed expenses: Manufacturing overhead 3020000 Marketing 290000 Administrative 2650000 Interest 710000 Total fixed expenses 6670000 Income before income taxes 3426080 Income tax (40%) 1370432 Net Income 2055648 Approximately equal to $2055650 3) Same NI would be obtained for same EBT. EBT for [b] = s*42.848%-6670000 EBT for [c] = s*53.748%-9464000 where s= the required sales Equating the above two equations we have s*0.42848-6670000=s*0.53748-9464000 Solving for s 2794000 = 0.109*s s = 2794000/0.109 = 25633027.5 Answer CHECK: Sales commission (19%) Sales 25633028 100.000% Variable expenses: Manufacturing 9779513 38.152% Sales commission (19%) 4870275 19.000% Total variable expenses 14649788.2 57.152% Contribution margin 10983239.8 42.848% Fixed expenses: Manufacturing overhead 3020000 Marketing 290000 Administrative 2650000 Interest 710000 Total fixed expenses 6670000 Income before income taxes 4313240 Income tax (40%) 1725296 Net Income 2587944 Own sales force: Sales 25633028 100.000% Variable expenses: Manufacturing 9779513 38.152% Sales commission (8.1%) 2076275 8.100% Total variable expenses 11855788.1 46.252% Contribution margin 13777239.9 53.748% Fixed expenses: Manufacturing overhead 3020000 Marketing (290000+2954000) 3244000 Administrative (2650000-160000) 2490000 Interest 710000 Total fixed expenses 9464000 Income before income taxes 4313240 Income tax (40%) 1725296 Net Income 2587944 NOTE THAT NI UNDER BOTH OPTIONS IS THE SAME. 4) Degree of operating leverage = Contribution margin/Income before taxes CM IBT DOL a) Agents' commission at 14% 10096000 3426000 2.95 b) Agents' commission at 19% 9041000 2371000 3.81 c) Own sales force 11340900 1876900 6.04