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# Question: Pittman Company is a small but growing

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, Pittmanâ€™s controller, has just prepared the companyâ€™s budgeted income statement for next year. The statement follows:

As Barbara handed the statement to Karl Vecci, Pittmanâ€™s president, she commented, â€œI went ahead and used the agentsâ€™ 15% commission rate in completing these statements, but weâ€™ve just learned that they refuse to handle our products next year unless we increase the commission rate to 20%.â€ â€œThatâ€™s the last straw,â€ Karl replied angrily. â€œThose agents have been demanding more and more, and this time theyâ€™ve gone too far. How can they possibly defend a 20% commission rate?â€ â€œThey claim that after paying for advertising, travel, and the other costs of promotion, thereâ€™s nothing left over for profit,â€ replied Barbara. â€œI say itâ€™s just plain robbery,â€ retorted Karl. â€œAnd I also say itâ€™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?â€ â€œWeâ€™ve already worked them up,â€ said Barbara. â€œSeveral 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 costs would increase by \$2,400,000 per year, but that would be more than offset by the \$3,200,000 (20% Ã— \$16,000,000) that we would avoid on agentsâ€™ commissions.â€ The breakdown of the \$2,400,000 cost follows:

â€œSuper,â€ replied Karl. â€œAnd I noticed that the \$2,400,000 is just what weâ€™re paying the agents under the old 15% commission rate.â€ â€œItâ€™s even better than that,â€ explained Barbara. â€œWe can actually save \$75,000 a year because thatâ€™s what weâ€™re having to pay the auditing firm now to check out the agentsâ€™ reports. So our overall administrative costs would be less.â€ â€œPull all of these numbers together and weâ€™ll show them to the executive committee tomorrow,â€ said Karl. â€œWith the approval of the committee, we can move on the matter immediately.â€ Required: 1. Compute Pittman Companyâ€™s break-even point in sales dollars for next year assuming: a. The agentsâ€™ commission rate remains unchanged at 15%. b. The agentsâ€™ 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 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 Company 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 expect to have on December 31 at the end of next year assuming: a. The agentsâ€™ commission rate remains unchanged at 15%. b. The agentsâ€™ commission rate is increased to 20%. c . 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.

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Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales.... \$16,000,000 Manufacturing costs: Variable .... Fixed overhead \$7,200,000 2,340,000 9,540,000 Gross margin .... Selling and administrative costs: Commissions to agents.. Fixed marketing costs.. Fixed administrative costs.. 6,460,000 2,400,000 120,000* 1,800,000 4,320,000 Net operating income . 2,140,000 Fixed interest cost.. 540,000 Income before income taxes. 1,600,000 Income taxes (30%). Net income .. 480,000 \$ 1,120,000 *Primarily depreciation on storage facilities. Salaries: Sales manager.. Salespersons.... Travel and entertainment. \$ 100,000 600,000 400,000 Advertising... 1,300,000 Total..... \$2,400,000

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