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Case $2-32($Algo$)$ Cost Structure; Break$-$Even and Target Profit Analysis $[$LO$2-4,$ LO$2-5,$ LO$2-6]$

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 sales commission of $15\%$ for all items sold.

Barbara Cheney, Pittman's controller, has just prepared the company's budgeted income statement for next year as follows:

$*$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' $15\%$ 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've 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 to work up some cost figures for us to look at$?"$

"We've already worked them up$,"$ said Barbara. "Several companies we know about pay a $7\mathrm{.}5\%$ 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 expenses would increase by $$3,600,000$ per year, but that would be more than offset by the $$4,800,000(20\%$$$24,000,000)$ that we would avoid on agents' commissions:"

The breakdown of the $$3,600,000$ cost follows:

$\backslash$table$[[$Salaries:$,],[,$ Sales manager,$150,000],[,$ Salespersons,$900,000],[$Travel and entertainment,$600,000],[$Advertising$,1,950,000$

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