PLEASE HELP!! CASE 3-33 Cost Structure; Break-Even and Target Profit Analysis [L
ID: 2510304 • Letter: P
Question
PLEASE HELP!!
CASE 3-33 Cost Structure; Break-Even and Target Profit Analysis [LO3–4, LO3–5, LO3–6]
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. The statement follows:
‘Primarily depreciation on storage facilities
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?”
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“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% × $16,000,000) that we would avoid on agents’ commissions.”
The breakdown of the $2,400,000 cost follows:
“Super,” replied Karl. “And I noticed that the $2,400,000 is just what we’re paying the agents under the old 15% commission rate.”
“It’s even better than that,” explained Barbara. “We can actually save $75,000 a year because that’s what we’re having to pay the auditing firm now 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.”
PLEASE HELP WITH QUESTIONS!! THANKS
Required:
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.
Assume that Pittman Company decides to continue selling through agents and pays the 20% commission rate. Determine the volume of sales that would be required to generate the same net income as contained in the budgeted income statement for next year.
Determine the volume of sales at which net income would be equal regardless of whether Pitt-man Company sells through agents (at a 20% commission rate) or employs its own sales force.
Compute the degree of operating leverage that the company would expect to have on December 31 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.
Use income before income taxes in your operating leverage computation.
Based on the data in requirements 1-4 above, make a recommendation as to whether the company should continue to use sales agents (at a 20% commission rate) or employ its own sales force. Give reasons for your answer.
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. . . . . . . . . . . . 1,20,000* 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
Explanation / Answer
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Working-1 Commission 15% Commission 20% Own Sales Force Working Sales. . . . . . . . . . . . . . . . . . . 16000000 16000000 16000000 Less: Variable Cost Variable Manufacturing exp 7200000 7200000 7200000 Agents Commission 2400000 3200000 1200000 7.5% Commission Total Variable Cost 9600000 10400000 8400000 Contribution Margin 6400000 5600000 7600000 Less: Fixed Cost Fixed overhead. . . . . . . . . . . . . . . 2340000 2340000 Fixed marketing expenses. . . . . . . . . . . . 120000 2520000 Additional fixed cost of 2400000 Fixed administrative expenses. . . . . . . 1800000 1725000 Saving audit fee of 75000 Total Fixed Cost 4260000 4260000 6585000 Net Operating Income 2140000 1340000 1015000 Fixed Interest Expenses 540000 540000 540000 Income before income taxes 1600000 800000 475000 Income Tax 30% 480000 240000 142500 Net Income 1120000 560000 332500 a. BEP with 15% Comission BEP=Fixed Cost/Contribution Margin Fixed Cost=2340000+120000+1800000+540000 4800000 Contribution Margin 6400000/16000000 40 BEP=4800000/40% 1.2E+07 b. BEP with 20% Comission Fixed Cost=2340000+120000+1800000+540000 4800000 Contribution Margin 5600000/16000000 35 BEP=4800000/35% 1.4E+07 c. BEP with own sales force Fixed Cost Working -1 6585000+540000 7125000 Contribution Margin 7600000/16000000 47.5 BEP=7125000/47.5% 1.5E+07 2. TO maintain budgeted Net Income To maintain budgeted Net Income 1120000 i.e. 1600000 before tax income (Fixed Cost+Target Profit)/Contribution Margin Fixed Cost at 20% Commission 4800000 From b Above Contribution Margin at 20% commission 35 From b Above Target Income before tax 1600000 Target Sales=(4800000+1600000)/35% 1.8E+07 3. Equal Net income Let Sale be x 20% Commission Own Sales force Let Sale be x x Variable Cost Ratio (100-Margin Ratio) 65% 52.5 Fixed Cost (From b and c) 4800000 7125000 0.65x+4800000=0.525x+7125000 x=2325000/0.125 x=18600000 where net income will be equal 4. Degree of operating Leavarage Contribution Margin/Income before tax Commission 15% Commission 20% Own Sales Force Contribution Margin From working-1 6400000 5600000 7600000 Income before tax (From working -1) 1600000 800000 475000 Degree of operating leavarage 4 7 16 5. Decision Since Net income is more in giving 20% commssion, should NOT employ own forceRelated Questions
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