Question
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
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 market its products. These agents are paid a commission of 15% of selling price for all items sold.
Karen, Pittmans controller just prepared the companys budgeted income statement for next year. The statement follows:
PITTMAN COMPANY
BUDGETED INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2017
SALES
$16,000,000
MANUFACTURING COSTS:
VARIABLE
$7,200,000
FIXED
2,340,000
9,540,000
GROSS MARGIN
6,460,000
SELLING & ADMIN COSTS:
COMMISSION TO AGENTS
2,400,000
FIXED MARKETING COSTS
120,000*
FIXED ADMIN COSTS
1,800,000
4,320,000
NET OPERATING INCOME
2,140,000
*All depreciation on storage facilities.
As Karen handed the statement to Mitt Romney, Pittmans president, she commented, I used the agents 15% commission rate in completing the statement.But weve just learned that the agents refuse to handle selling our product next year unless we increase the commission rate to 20%."
Mitt replied How can they possibly defend a 20% commission rate? And I say its time we fire those guys and get our own sales force.
Karen said We can hire our own sales staff and pay them 7.5% commission, along with a small salary. Of course, we would have to handle all promotion costs too. We figure our fixed costs would increase by $2,500,000 per year.
The breakdown of the $2,500,000 cost figure is as follows:
Salaries:
Sales manager$100,000
Salespersons700,000
Travel and Entertainment400,000
Advertising1,300,000
Total$2,500,000
Required:
Compute Pittmans break-even point in sales dollars for next year assuming:
a.that the agents commission rate remains unchanged at 15%
b.that the agents commission rate is increased to 20%
c.that the company employs its own sales force
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