Martin Corporation manufactures pharmaceutical products that are sold through a
ID: 2483267 • Letter: M
Question
Martin Corporation manufactures pharmaceutical products that are sold through a network of sales agents. The agents are paid a commission of 20% of sales. The income statement for the year ending December 31, 2011 under two scenarios, is as follows (Click the icon to view the income statements.) Martin is considering hiring its own sales staff to replace the network of agents. Martin will pay its salespeople a commission of 10% and incur additional fixed costs of $2,700,000 Requirements 1. Calculate Martin Corporation's 2011 contribution margin percentage, breakeven revenues, and degree of operating leverage under the two scenarios. (You will first have to recast the 2011 income statement assuming Martin has hired its own sales staff.) 2. Describe the advantages and disadvantages of each type of sales alternative 3. In 2012, Martin uses its own salespeople, who demand a 15% commission. If all other cost behaviour patterns are unchanged. how much revenue must the salespeople generate in order to earn the same operating income as in 2011? Begin by determining the tormula, then enter the amounts to calculate the percentage. Round your answer to the nearest whole percent.) Contribution (| Fixed costs |.| Contribution margin!)x 100 )x 100 )x 100 margin % 34% 5,916,000 Using Sales Agents( Using Own Sales Force( Calculate Martin's 2011 breakeven point in revenues. Begin by determining the formula, then enter the amounts to calculate the breakeven points. (Round your answer up to the nearest whole dollar.) Breakeven revenues Using Sales Agents Usind Own Sales Force Choose from any list or enter any number in the input fields, then continue to the next questionExplanation / Answer
1)
a) Contribution margin %:
Contribution/Sales
Using Sales Agent = [(27,000,000-12,420,000-5,400,000)/27,000,000]*100 = 34%
Using Own Sales Force = [(27,000,000-12,420,000-2,700,000)/27,000,000]*100 = 44%
b) Break-Even-Sales:
Fixed Cost/Contribution Margin
Using Sales Agent = (2,650,000+3,266,000)/0.34 = $17,400,000
Using Own Sales Force = (2,650,000+5,966,000)/0.44 = $19,581,818
c) Degree of Operating Leverage:
Contribution/Operating profit
Using Sales Agent = (27,000,000-12,420,000-5,400,000)/3,264,000 = 2.81
Using Own Sales Force = (27,000,000-12,420,000-2,700,000)/3,264,000 = 3.64
2) The calculations indicate that at sales of $27,000,000, a % change in sales and contribution margin will result in 2.81 times that % change in operating profits and 3.64 times that % change in operating profits if Martin employs its own sales staff.
The higher contribution margin per dollar of sales and higher fixed costs gives Martin high operating leverage, that is, higher benefits if revenues increase but higher risks if revenues decrease.
Martin also has to consider the skill levels and incentives under the two alternatives. Sales Agents have more incentive compensation and hence may be more motivated to increase sales. On the other hand own sales force may be more knowledgeable and skilled in selling the company's products. That is, the sales itself will be affected by who sells and by the nature of the compensation plan.
3) The sales required to pay 15% commission to own sales force and make the same operating profit of 3,264,000:
We have the equation
3,264,000 = Sales - VC of 61% of sales (56+5) - Fixed cost of 8,616,000
11,880,000 = 0.39 of Sales
Sales = 11,880,000/0.39 = $30,461,538
Check:
Sales 30,461,538
Less: Variable costs
Manufacturing (46%) - 14,012,307
Selling (15%) - 4,569,231 18,581,538
Contribution margin 11,880,000
Less fixed costs (2650000+5966000) 8,616,000
Operating profit 3,264,000
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