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Pittman Company is a small but growing manufacturer of telecommunications equipment

Pittman Company is a small but growing manufacturer of telecommunications equipment
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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 15% of selling price for all items sold. Barbara Cheney, Pittman’ s controller (who got an A in managerial accounting), 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 SALES $16,000,000 MANUFACTURING COSTS: VARIABLE $7,200,000 FIXED 2,340,000 9,540,000 GROSS MARGIN 6,460,000 SELLING & ADMIN COSTS: COMMISSION TO AGENTS 2,400,000 FIXED MARKETING COSTS 120,000* FIXED ADMIN COSTS 1,800,000 4,320,000 NET OPERATING INCOME 2,140,000 LESS FIXED INTEREST COST 540,000 INCOME BEFORE TAXES 1,600,000 *primarily depreciation on storage facilities. As Barbara handed the statement to Karl Smart, 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 have 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 (meaning you!) to work up some cost figures for us to look at?” “We’ve already worked them up” replied Barbara. “Several companies we know pay about 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 costs would increase by $2,400,000 per year, but that would be more than offset by the $3,200,000 (20% x $16,000,000) that we would avoid on agents’ commissions.” The breakdown of the $2,400,000 cost figure is as follows: Salaries: Sales manager $ 100,000 Salespersons 600,000 Travel and Entertainment 400,000 Advertising 1,300,000 Total $2,400,000 “Super,” replied Karl. “ and I note that the $2,400,000 is just what we are 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 are paying 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,” replied Karl. “ With the approval of the committee, we can move on the matter immediately.” Required: 1. Compute Pittman’s break-even point in sales dollars for next year assuming: a. that the agents commission rate remains unchanged at 15% b. that the agents commission rate is increased to 20% c. that the company employs its own sales force 2. Assume that Pittman decides decides to continue selling through the 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. 3. Determine the volume of sales at which net income would be equal regardless of whether Pittman 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 have to have on December 31 at the end of next year assuming: a. that the agents commission rate remains unchanged at 15% b. that the agents commission rate is increased to 20% c. that the company employs its own sales force Use income before income taxes in your operating leverage computation. 5. Based on the data in (1) through (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 that is supported by both your calculations and any other pertinent information NOTE: This question is NOT our property; we are only suggesting solution of this question.

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