I would recommend preparing side-bv-side income statements comparing all three options before working through any of the problems - this will help you move through the questions quicker and make sure all the numbers you are using are correct - if you do this, be sure to adjust the variable costs and income taxes using the tax rate in each scenario #2 - Use Target Income Before Income Taxes of $1,600,000 in the target prot analvsis instead of using net income #3 - Setup the following equation to solve for X: (Variable Expense Ratio 2-: X} + Fixed Costs = {Variable Expense Ratio 3: X] + Fixed Costs #4 - Use Income before Income Taxes #5 - Be sure to consider other factors besides just the numbers - think through and discuss this from a business perspective Complete #1-4 in Excel, Complete #5 in Word using complete sentences and paragraphs. Select cases are ava CASE 5-32 Cost Structures Break-Even and Target Profit Analysis LO5-4, LO5-5, L05-0 CAsian Company 'S out growing manufacturer of telecommunications equipment. Ple company has no sems force of its own; rather, it relies completely on independent sales agent to market 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 state- ment for next year as follows: Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales . .... Manufacturing expenses: $ 16,000,000 Variable. .. $7,200,000 Fixed overhead ..... 2,340,000 9,540,000 Gross margin . ... 6,460,000 Selling and administrative expenses: Commissions to agents . . . . . . . 2,400,000 Fixed marketing expenses. . 120,000 Fixed administrative 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 Income taxes (30%) . ..... . .. 480,000 Net income . .. . . . . . . . $ 1, 120,000 *Primarily depreciation on storage facilities. done As Barbara handed the statement to Karl Vecci, Pittman's president, she commented, "I went ahead and used the agents' 15% 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 20%." "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 20% 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 7.5% 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 $2,400,000 per year, but that would be more than offset by the $3,200,000 (20% x $16,000,000) that we would avoid on agents' commissions." The breakdown of the $2,400,000 cost follows: bomuenoo Salaries: . . . $ 100,000 Sales manager. . .. ... . 600,000 Gainon Salespersons . . ... 400,000 Travel and entertainment. . .... 1,300,000 Advertising . ...... $2,400,000 Total. .Chapter 5muley lead Super," replied Karl. "And I noticed that the $2,400,000 equals what we're paying the agents It's even better than that," explained Barbara. "We can actually save $ 75,000 a year because under the old 15% commission rate." that's what we're paying our auditors to check out the agents' reports. So our overall administrative expenses would be less." Pull all of these numbers together and we'll show them to the executive committee tomor. row," said Karl. "With the approval of the committee, we can move on the matter immediately." Required: 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 decides to continue selling through agents and pays the 20% commission rate. Determine the dollar sales that would be required to generate the same net income as contained in the budgeted income statement for next year. 3. Determine the dollar sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 20% commission rate) or employs its own sales force. 4 . Compute the degree of operating leverage that the company would expect to have at the end of 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. 5 . Use income before income taxes in your operating leverage computation. Based on the data in (1) through (4) above, make a recommendation as to whether the com- pany should continue to use sales agents (at a 20% commission rate) or employ its own sales force. Give reasons for your answer. (CMA, adapted) (9:08) 29x6damp ng Mixed Costs The main body of Chapter 5 assumed that all costs could be readily classified as varighl fixed. In reality, many costs contain both variable and fixed c ixed costs. The purpose of this appendix is to descri es can use to separate mixed costs into abling cost-volun