Pittman Company is a small but growing manufacturer of telecommunications equipment. They have 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 20% for all items sold. Barbara Cheney, 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
Sales $20,200,000
Manufacturing expenses:
Variable $7,900,000
Fixed overhead 2,900,000 10,800,000
Gross margin 9,400,000
Selling and administrative expenses
Commissions to agents 4,040,000
Fixed marketing expenses 260,000*
Fixed administrative expenses 2,500,000 6,800,000
Net operating income 2,600,000
Fixed interest expenses 680,000
Income before income taxes 1,920,000
Income taxes (25%) 480,000
Net income $1,440,000
(*) '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' 20% commission rate in completing these statements, but we've just learned that they refuse to handle our product next year unless we increase the commission to 25%. "
"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 25% commission rate?"
"They claim that after paying for advertising, travel, and other costs of promotion, there's nothing leftover 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 some cost figures for us to look at?"
"We've already worked them up, " said Barbara. "Several companies we know about pay a 7.8% 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 $4,040,000 per year, but that would be more than offset by the $5,050,000 (25% x $20,200,000) that we would avoid on agents' commission. "
The breakdown of the $4,040,000 cost follows:
Salaries:
Sales manager $240,000
Salespersons 1,300,000
Travel and entertainment 960,000
Advertising 1,540,000
Total $4,040,000
"Super, " replied Karl. "And I noticed that the $4,040,000 is just what we're paying the agents under the old 20% commission rate."
"It's even better than that," explained Barbara. "We can actually save $145,000 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."
"Put 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."
Required
1. Compute Pittman Company's break-even point in dollar sales for next year assuming:
a. The agents' commission rate remains unchanged at 20%
b. The agents' commission rate is increased to 25%
c. The company employs its own sales force.
2. Assume that Pittman Company decides to continue selling through agents and pays the 25% commission rate. Determine the volume of sales that would be required to generate the same net income as contained in the budgeted income statements for next year.