Pittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales Page 2 force of its own, rather, it relies completely on independent sales agents to market its products. These agents are paid a sales commission o 15% for all items sold. Barbara Cheney, Pittman's controller, has just prepared the company's budgeted income statement for next year as follows: Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales $ 16,000,000 Manufacturing expenses 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 1.600,000 480,000 Income taxes (30%) Net income $ 120,000 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." Kart 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 "1 say it's just plain robbery." retorted Katl. "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 75% 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% $16.000.000) that we would avoid on agents' commissions." The breakdown of the $2.400.000 cost follows: Salaries Sales manager $ 100,000 Salespersons 600.000 Travel and entertainment 100.000 Advertising 1.300.000 Total $2,400,000 Super replied at 'And I noticed that the $2.400.000 equals what we're paying the enter the old 15% commission nie Pe 24 is even better than that plained Barbara "We can actually save $75,000 a year because that's what were paying oor ditors to check but the reports. So oor die perse word be less of the other we show them to the sective come to KarlWah the approval of the Required 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% 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 niet 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 1. The agents' commission rate remains unchanged at 15% The agents commission rate is increased to 20% The company employs its own salesforce Use income before income taxes in your operating leverage competition 5. Based on the data in through (4) above, make a recommendation as to whether the company should continue to use sales cents at 20% commissione) or employ its own salesforce. Give reasons for your answer CMA adapted