Pittman Company is a small but growing manufacturer oftelecommunications equipment. The company has no sales force of itsown; rather, it relies completely on independent sales agents tomarket its products. These agents are paid a sales commission of15% for all items sold.

Barbara Cheney, Pittman’s controller, has just prepared thecompany’s budgeted income statement for next year as follows:

Pittman Company Budgeted Income Statement For the Year Ended December 31
Sales				$	23,000,000
Manufacturingexpenses:
Variable	$	10,350,000
Fixedoverhead		3,220,000			13,570,000
Grossmargin					9,430,000
Selling andadministrative expenses:
Commissions toagents		3,450,000
Fixed marketingexpenses		161,000	*
Fixedadministrative expenses		2,080,000			5,691,000
Net operatingincome					3,739,000
Fixed interestexpenses					805,000
Income beforeincome taxes					2,934,000
Income taxes(30%)					880,200
Net income				$	2,053,800

*Primarily depreciation on storage facilities.

As Barbara handed the statement to Karl Vecci, Pittman’spresident, she commented, “I went ahead and used the agents’ 15%commission rate in completing these statements, but we’ve justlearned that they refuse to handle our products next year unless weincrease the commission rate to 20%.”

“That’s the last straw,” Karl replied angrily. “Those agentshave been demanding more and more, and this time they’ve gone toofar. How can they possibly defend a 20% commission rate?”

“They claim that after paying for advertising, travel, and theother costs of promotion, there’s nothing left over for profit,”replied Barbara.

“I say it’s just plain robbery,” retorted Karl. “And I also sayit’s time we dumped those guys and got our own sales force. Can youget your people to work up some cost figures for us to lookat?”

“We’ve already worked them up,” said Barbara. “Several companieswe know about pay a 7.5% commission to their own salespeople, alongwith a small salary. Of course, we would have to handle allpromotion costs, too. We figure our fixed expenses would increaseby $3,450,000 per year, but that would be more than offset by the$4,600,000 (20% × $23,000,000) that we would avoid on agents’commissions.”

The breakdown of the $3,450,000 cost follows:

Salaries:
Sales manager	$	143,750
Salespersons		862,500
Travel and entertainment		575,000
Advertising		1,868,750
Total	$	3,450,000

“Super,” replied Karl. “And I noticed that the $3,450,000 equalswhat we’re paying the agents under the old 15% commissionrate.”

“It’s even better than that,” explained Barbara. “We canactually save $105,800 a year because that’s what we’re paying ourauditors to check out the agents’ reports. So our overalladministrative expenses would be less.”

“Pull all of these numbers together and we’ll show them to theexecutive committee tomorrow,” said Karl. “With the approval of thecommittee, we can move on the matter immediately.”

Required:

1. Compute Pittman Company’s break-even point in dollar salesfor 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 throughagents and pays the 20% commission rate. Determine the dollar salesthat would be required to generate the same net income as containedin the budgeted income statement for next year.

3. Determine the dollar sales at which net income would be equalregardless of whether Pittman Company sells through agents (at a20% commission rate) or employs its own sales force.

4. Compute the degree of operating leverage that the companywould 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 operatingleverage computation.