Reference no: EM131240210

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 markets 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:

Sales..........................................$16,000,000
Manufacturing expenses:
variable....................$7,200,000
fixed overhead...........2,340,000...........$9,540,000
Gross Margin........................................6,460,000
Selling and Admin expenses
commissions to agents...2,400,000
fixed marketing expenses..120,00
Fixed admin expenses........1,800,000......4,320,000
Net operating income..............................2,140,000
Fixed interest expenses............................540,000
Income before income taxes......................1,600,000
incomes taxes (30%)................................480,000
Net income..............................................1,120,000

This statement was made using agents 15% commission rate, but next year will increase to 20%. Several companies they know about pay a 7.5% commission to their own salespeople, along with a small salary. Of course, they have to handle promotional cost, too. They figure their fixed expenses would increase by $2,400,000 per year, but that would be more than offset by the $3,200,000 (20% X $16,000,000) that they would avoid on agents' commissions.

The break down of the $2,400,000 cost follows:

Salaries
Sales manager....................$100,000
Salespersons.......................600,000
Travel and entertainment........400,000
Advertising............................1,300,000
Total......................................$2,400,000

They save $75,000 a year because that's what they are having to pay the auditing firm now to check out the agents' reports. So administration expenses would be less.

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 decided to continue selling through agents and pays the 20% 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.

3.) Determine the volume of sales at which net income would be equal regardless of whether pittman company sells through agents (at 20% commission rate) or employs its own sales force.

4.) Compute the degree of operating leverage that the company would expect to have on December 31 at the end of next year assuming:

a. the agents' commission rate remains unchanged at 15%
b. the agents' commission rate is increased at 20%
c. the company employs its own sales force
-use income BEFORE income taxes in your operating leverage computation

5.) Based on the data in (1) through (4) above, make a recommendation as to whether the company should continue to use sales agents (at 20% commission rate) or employ its own sales force. Give reasons for your answer.