CVP ANALYSIS

Pitman company makes and sells electronic items. The company has independent sales agents who are paid 15% of revenue as sales commissions. The company has come up with the budget for next year.

Sales $16 m

Manufacturing expenses

Variable $7.2m

Fixed $2.34m

Selling and admin expenses

Sales commission $2.4m

Fixed marketing $120,000 ( all depreciation)

Fixed admn $1.725m

Fixed Auditing expense $75,000 ( to audit independent sales people)

Other expenses

Interest expense $540,000

Pre tax income $1.6m

Income tax @30% $480,000

Net income $1.12m

The sales agents are now demanding a 20% commission rate. So the company is thinking of creating its own sales department. The new sales department will have the following fixed costs:

Sales manager salary $100,000

Salespeople salary $600,000

Travel $400,000

Advertising $1.3m

In addition to the above, sales people will also be paid 7.5% commission rate. The sales department option will eliminate the auditing expense of $75,000.

REQUIRED

1. Compute the break even point in dollar sales under each of the following option.

1. Agents commission rate remain unchanged at 15%
2. Agents commission rate is increased to 20%
3. Company sets its own sales department

2. Assume the company gives in to the demand of sales agents and agrees to give 20% rate. Determine the dollar sales that would be required to generate the same net income budgeted above.
3. Determine the sales dollar at which the company would be indifferent between giving 20% commission rate and setting up its own sales department. (i.e.) the net income would be the same under either option.
4. Compute the degree of operating leverage under each of the options listed in question 1.
5. Based on your answers for question 4, what would be the change in net income if sales decreased by 10%?

Tax rate remains at 30% for all options.

please answer all questions with explanations