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 sales commission of 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 $ 25,000,000 Manufacturing expenses Variable $11,250,000 Fixed overhead 3. see, eee 14,750,000 Cross margin 10,250,000 Selling and administrative expenses Commissions to agents 3,750,000 Fixed marketing expenses 175,000 Fixed administrative expenses 2.160,000 6,885,000 Net operating income 4,165,000 Fixed interest expenses 875,000 Income before income taxes 3,290.000 Income taxes (38) 932,000 Tiet incore 5.2, 303,000 *Primarily depreciation on storage facilities As Barbara handed the statement to Karl Veco, 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. Korreplied angrily "Those agents have been demanding more and more, and this time they ve gone too for 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 "soy it's just plain robbery, retorted Karl "And I also say it's time we clumped those guys and got our own soles 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 story Of course, we would have to handle all promotion costs, too. We figure our food expenses would increase by $3,750,000 per year, but that would be more than offset by the $5,000,000 (20% - $25.000.000 that we would avoid on agents commissions "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 $3,750,000 per year, but that would be more than offset by the $5,000,000 20% * $25,000,000) that we would avoid on agents commissions The breakdown of the $3,750,000 cost follows Salaries: Sales manager 5 156,250 Salespersons 937,500 Travel and entertainment 625,000 Advertising 2,031,250 Total $19,750,000 Super replied Karl "And I noticed that the $3,750,000 equals what we're paying the agents under the old 15% commission rate "It's even better than that," explained Barbara. "We can actually save $115.000 a year because 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 tomorrow 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 (et 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% The company employs its own sales force Use income before income taxes in your operating leverage computation