Air Tool Australia (ATA) is considering the addiction of a new valve to its product line. The valve would be used by manufacturers of Pneumatic equipment. The company anticipates starting with a relatively low sates volume and then boosting demand over several years. A new salesperson must be hired because ATA's current sales force is working at full Capacity. Two salary packages are under consideration;

• Plan A: An annual salary of $49 500 plus a 10 percent commission based on gross dollar sales.

• Plan B: An annual salary of $148 500 and no commission.

ATA will purchase the valve for $112.50 and sell it for $18o. Anticipated demand during the first year is 6000 units. (Ignore income taxes.)

Before considering the questions below, you may wish to revisit the malarial on incentive systems in Chapter 13.

Required:

1. Calculate ATA's break-even point for Plan A and Plan B.

2. What is meant by the term operating 1evercge?

3. Analyse the cost structures of both plans at the anticipated demand of 6000 units. Which of the two plans is more highly leveraged? Why?

4. Assume that a general economic downturn occurs during Year 2, with product demand falling from 6000 to 5000 units. Determine the percentage decrease in company net profit if ATA had adopted Plan A.

5. Repeat requirement 4 for Plan B. Compare Plan A and Plan B, and explain a major factor that underlies any resulting differences.

6. Briefly discuss the likely profitability impact of an economic recession for more highly automated manufacturers. What can you say about the risk associated with these firms?