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				$	24,500,000
Manufacturing expenses:
Variable	$	11,025,000
Fixed overhead		3,430,000			14,455,000
Gross margin					10,045,000
Selling and administrative expenses:
Commissions to agents		3,675,000
Fixed marketing expenses		171,500	*
Fixed administrative expenses		2,140,000			5,986,500
Net operating income					4,058,500
Fixed interest expenses					857,500
Income before income taxes					3,201,000
Income taxes (30%)					960,300
Net income				$	2,240,700

*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 $3,675,000 per year, but that would be more than offset by the$4,900,000 (20% × $24,500,000) that we would avoid on agents’commissions.”

The breakdown of the $3,675,000 cost follows:

Salaries:
Sales manager	$	153,125
Salespersons		918,750
Travel and entertainment		612,500
Advertising		1,990,625
Total	$	3,675,000

“Super,” replied Karl. “And I noticed that the $3,675,000 equalswhat we’re paying the agents under the old 15% commissionrate.”

“It’s even better than that,” explained Barbara. “We canactually save $112,700 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.