CVP Comprehensive Problem

Gupta Travel is a charter airline service for corporate clients traveling between Atlanta and Boston. The company leases one jet aircraft and flies an average of 150 one-way trips per year. Guptas marketing strategy is to sell a more enjoyable travel experience than its rivals in the commercial airline industry. Gupta arranges ground transportation in Atlanta and Boston for its clients, offers a more spacious cabin with larger seats and more legroom, and serves gourmet meals on its flights. Gupta does not sell its services to individuals; rather its services are marketed directly to corporate clients. Therefore, when Gupta books a flight for a client, it is not merely selling a few seats on its aircraft. Rather, the corporate client is booking the use of the aircraft for its travel needs. Gupta uses a network of commissioned travel agents to sell its services. These agents are not employees of Gupta, and the agents receive a 20 percent commission (no fixed salary) on each flight sold on Gupta Travel.

Gupta had the following income statement for the year ending December 31, 2014.

Gupta Travel

Income Statement

For the Year Ending 12/31/2014

Sales Revenue (150 one-way flights _ $40,000 per flight) $6,000,000

Commissions Expense (20 percent of Sales Revenue) 1,200,000

Annual Lease ExpenseAirplane 1,100,000

Annual Fee for Airport Ground Crew Services 800,000

Flight Crew Expense (150 one-way flights _ $1,500 per flight) 225,000

Fuel Expense (150 one-way flights _ $1,000 per flight) 150,000

Food Expense (150 one-way flights _ $800 per flight) 120,000

Ground Transportation Expense (150 one-way flights _ $200 per flight) 30,000

Other Fixed General and Administrative Expenses 200,000

Fixed Interest Expense 220,000

(1) Prepare the contribution margin Income Statement (ignore income tax)

(2) What is Guptas current breakeven point in flights?

(3) At the end of 2013, Guptas management learned that its commissioned travel agents are demanding an increase in their commission rate to 30 percent per flight for the upcoming year. As a result, Guptas president has decided to investigate the possibility of hiring an in-house sales staff to replace the commissioned travel agents. Guptas accounting department compiled the following information to be used to evaluate the cost of establishing an in-house sales department.

Costs of Establishing an In-House Sales Department

The accounting department estimates that Gupta would need to hire four salespeople at an average payroll cost of $80,000 per employee to cover the workload of the current travel agents. Also, in order to hire highly qualified individuals for these positions, the compensation package must include commissions. To be competitive with the industry-standard commission rate, Gupta must offer a 15 percent commission on each flight sold in addition to the salary. The cost of the in house sales department will also include travel costs and support staff. Travel and entertainment expense is expected to total $500,000 (fixed) for the year, and the annual cost of support staff positions will be fixed at $120,000. Gupta currently relies on the travel agents to sell its services. If Gupta were to replace its commissioned travel agents with an in-house sales department, then it would have to bear more of the cost of advertising its services. In order to maintain the companys image and manage the transition from established travel agents to an in-house sales staff, the accounting department recommends spending $500,000 (fixed) annually on advertising.

Use the December 31, 2014 Income Statement (with 150 flights sold) to estimate Guptas breakeven point in units (flights) if the company hires its own sales force and increases its advertising costs. Based on your answer, what amount of sales revenue would the company generate at this breakeven point?

(4) Assume that Gupta decides not to hire its own sales force, but instead consents to give its current commissioned travel agents the raise they are demanding. How many flights must the company sell (with the new commission rate) to generate the same net income that was reported in 2016?

(5) Management must choose between: (a) hiring its own sales force and (b) compensating its current network of travel agents with a higher commission rate.

(i ) What is the profit formula for alternative (a), hiring an in-house sales force?

(ii ) What is the profit formula for alternative (b), increasing the commission rate of the current travel agents?

(iii ) At what level of sales volume (in flights) would management be indifferent between these two alternatives? (Indifference means the sales volume [units] that would produce the same profit between the alternatives.)