Case 2-32 Cost Structure; Break-Even and Target Profit Analysis

First- answer the case study 2-32 in McGraw Hill Connect. Then, use the correct answers to write the case study report. The actual case study in McGraw Hill Connect is worth 10 points. I have given you unlimited opportunities to get the correct answers on the case study in Connect. The remainder of the 50 points comes from your report.

Answer each question as if you were a consultant hired by the company and are presenting to the president.

For each answer explain the terminology and concepts used. For example, in #1 rather than just give the breakeven for each scenario, explain the change in the volume of sales, explain the calculation - this is a professional report from a consultant to an executive committee.

Use outside sources when necessary BUT MAKE SURE YOU CITE THEM!

When giving a recommendation, back it up with numbers.

This particular answer should be an executive committee report that is no more than 4 pages in length

Required:

1. Compute Pittman Companys break-even point in dollar sales for next year assuming:

a. The agents commission rate remains unchanged at 15%.

b. The agents 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 dollar sales that would be required to generate the same net income as contained in the budgeted income statement for next year.

3. Determine the dollar 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 at the end of next year assuming:

a. The agents commission rate remains unchanged at 15%.

b. The agents commission rate is increased to 20%.

c. The company employs its own sales force.

Use income before income taxes in your operating leverage computation.

Explanation

Before proceeding with the solution, it is helpful first to restructure the data into contribution format for each of the three alternatives. (The data in the statements below are in thousands.)

	15% Commission		20% Commission		Own Sales Force
Sales	$ 23,500.00	100%	$ 23,500.00	100%	$ 23,500.00	100.0%
Variable expenses:
Manufacturing	10,575.00		10,575.00		10,575.00
Commissions (15%, 20%, 7.5%)	3,525.00		4,700.00		1,762.50
Total variable expenses	14,100.00	60%	15,275.00	65%	12,337.50	52.5%
Contribution margin	9,400.00	40%	8,225.00	35%	11,162.50	47.5%
Fixed expenses:
Manufacturing overhead	3,290.00		3,290.00		3,290.00
Marketing	164.50		164.50		3,689.50*Footnote asterisk
Administrative	2,100.00		2,100.00		1,991.90**
Interest	822.50		822.50		822.50
Total fixed expenses	6,377.00		6,377.00		9,793.90
Income before income taxes	3,023.00		1,848.00		1,368.60
Income taxes (30%)	906.90		554.40		410.58
Net income	$ 2,116.10		$ 1,293.60		$ 958.02

*Footnote asterisk$164,500 + $3,525,000 = $3,689,500

**$2,100,000 $108,100 = $1,991,900

When the income before taxes is zero, income taxes will also be zero and net income will be zero. Therefore, the break-even calculations can be based on the income before taxes.Break-even point in dollar sales if the commission remains 15%:

Dollar sales to break even = Fixed expenses CM ratio = $6,377,000 0.40 = $15,942,500

Break-even point in dollar sales if the commission increases to 20%:

Dollar sales to break even = Fixed expenses CM ratio = $6,377,000 0.35 = $18,220,000

Break-even point in dollar sales if the company employs its own sales force:

Dollar sales to break even = Fixed expenses CM ratio = $9,793,900 0.475 = $20,618,737

In order to generate a $2,116,100 net income, the company must generate $3,023,000 in income before taxes. Therefore,

Dollar sales to attain target = (Target income before taxes + Fixed expenses) CM ratio

= ($3,023,000 + $6,377,000) 0.35

= $9,400,000 0.35 = $26,857,143

To determine the volume of sales at which net income would be equal under either the 20% commission plan or the company sales force plan, we find the volume of sales where costs before income taxes under the two plans are equal.

X = Total sales revenue

0.65X + $6,377,000 = 0.525X + $9,793,900

0.125X = $3,416,900

X = $3,416,900 0.125

X = $27,335,200

Thus, at a sales level of $27,335,200 either plan would yield the same income before taxes and net income. Below this sales level, the commission plan would yield the largest net income; above this sales level, the sales force plan would yield the largest net income.

a., b., and c.

	15% Commission	20% Commission	Own Sales Force
Contribution margin (Part 1) (a)	$ 9,400,000	$ 8,225,000	$ 11,162,500
Income before taxes (Part 1) (b)	$ 3,023,000	$ 1,848,000	$ 1,368,600
Degree of operating leverage: (a) (b)	3.11	4.45	8.16