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 11% of selling price for all items sold. XXXXX XXXXXey, Pittman’s controller, has just prepared the company’s budgeted income statement for next year. The statement follows:
Pittman Company Budgeted Income Statement For the Year Ended December 31
Fixed overhead 2,210,000 9,410,000
Gross margin 6,710,000
Selling and administrative costs:
Commissions to agents 1,773,200
Fixed marketing costs 109,000*
Fixed administrative costs 1,720,000 3,602,200
Net operating income $3,107,800
Fixed interest cost 532,000
Income before income taxes 2,575,800
Income taxes (30%) 772,740
Net income $1,803,060
*Primarily depreciation on storage facilities. As XXXXX XXXXXded the statement to Karl Vecci, Pittman’s president, she commented, “I went ahead and used the agents’ 11% 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 16%.” “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 16% 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?” “We’ve already worked them up,” said Barbara. “Several companies we know about pay a 5.5% 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 costs would increase by $1,773,200 per year, but that would be more than offset by the $2,579,200 (16% × $16,120,000) that we would avoid on agents’ commissions.” The breakdown of the $1,773,200 cost follows:
Sales manager. $117,000
Travel and entertainment 420,000
“Super,” replied Karl. “And I noticed that the $1,773,200 is just what we’re paying the agents under the old 11% commission rate.” “It’s even better than that,” explained Barbara. “We can actually save $67,000 a year because that’s what we’re having to pay the auditing firm now to check out the agents’ reports. So our overall administrative costs would be less.” “Pull all of these numbers together and we’ll show them to the executive committee tomorrow,” said Karl. “With the approval of the committee, we can move on the matter immediately.”
Determine the volume of sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 16% commission rate) or employs its own sales force. (Round contribution ratio (%) to 3 decimal places, e.g., .1234 as .123 or 12.3%. Round your answer to the nearest dollar amount. Omit the "$" sign in your response.)
Volume of sales $___________
Requirement 4: Compute the degree of operating leverage that the company would expect to have on December 31 at the end of next year assuming:(Round your answers to 2 decimal places.)
(a) The agents’ commission rate remains unchanged at 11%.
(b) The independent sales agents' commission rate increases to 16%.
(c) The company employs its own sales force.
11% Commission 16%Commission Own Sales Force
leverage: __________ ___________ ___________
Requirement 5: Make a recommendation as to whether the company should continue to use sales agents (at a 16% commission rate) or employ its own sales force. Give reasons for your answer.