David Jones Limited manufactures guest supplies that are sold to Hotels through a network of independent sales agents located in Australia. These sales agents sell a variety of products to Hotels in addition to David Jones supplies. The sales agents are currently paid an 18% commission on sales, and this commission rate was used when David Jones's management prepared the following budgeted absorption income statement for the upcoming year.

David Jones Limited

Budgeted Income Statement

Sales $ 30,000,000

Cost of goods sold:

Variable 17,400,000

Fixed 2,800,000 20,200,000

Gross margin 9,800,000

Selling and administrative expenses:

Commissions 5,400,000

Fixed advertising expense 800,000

Fixed administrative expense 3,200,000 9,400,000

Net operating income $ 400,000

Since the completion of the above statement, David Jones has learned that the independent sales agents are demanding an increase in the commission rate to 20% of sales for the upcoming year. This would be the third increase in commissions demanded by the independent sales agents in five years. As a result, David Jones 's management has decided to investigate the possibility of hiring its own sales staff to replace the independent sales agents. David Jones 's controller estimates that the company will have to hire eight salespeople to cover the current market area, and the total annual payroll cost of these employees will be about $700,000, including fringe benefits. The salespeople will also be paid commissions of 10% of sales. Travel and entertainment expenses are expected to total about $400,000 for the year. The company will also have to hire a sales manager and support staff whose salaries and fringe benefits will come to $200,000 per year. To make up for the promotions that the independent sales agents had been running on behalf of David Jones, management believes that the company's budget for fixed advertising expenses should be increased by $500,000.

Instructions:

1. Determine the volume of sales at which net operating income would be equal regardless of David Jones Limited sells through agents (at a 20% commission rate) or employs its own sales force.
3. Makegraph on which you plot the profits of both of the following alternatives.
4. a. The independent sales agents' commission rate increases to 20%.
5. b. The company employs its own sales force.
7. Makememo to the president of David Jones which you make a recommendation as to whether the company should continue to use independent sales agent (at a 20% commission rate) or employ its own sales force. Fully explain the reasons for your recommendation in the memo.