I.

TITLE OF THE CASE: Pittman company

II.

FACTS OF THE CASE:

Pittman company is a small but growing manufacturer of
telecommunications equipment.
The company has no sales force of its own; it avails the service of sales
agents to market its products. These agents are being paid 15% of the
selling price as commissions.
Barbara Cheney, Pittmans controller, created the companys budgeted
income statement for next year as stated below

The breakdown of the $2,400,000 cost follows:

Barbara handed it to the companys president and informed him that

agents now refuse to handle their products unless commissions will be
increased into 20%
With this demand of the sales agent; the company is now considering the
option of establishing its own sales force with lesser commission rate of
7.5% and a small salary.

III.

STATEMENT OF THE PROBLEM/REQUIREMENTS:

1. Compute the Pittman Companys break even point in sales dollars 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 employ its own sales force.
2. Assume that Pittman Company decides to continue selling through
agents and pays the 20% commission rate. Determine the volume of
sales that would be required to generate the same net income as
contained in the budgeted income statement for next year.

3. Determine the volume of sales at which net income would be equal

regardless of whether pittman company sells through agents or employ
its own sales force.
4. Compute the degree of operating leverage that the company would
expect to have on Dec 31 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
computations
5.

IV.

Based on the data in 1 to 4 above make a recommendation as to

whether the company should continue to use sales agents (at a 20%
commission rate) or employ its own sales force. Give reasons for your
answer.

ANALYSIS/SOLUTION
1. Companys breakeven point at different commission rates are as
follows
a. When commission rate remains unchanged at 15%
Based on below budgeted income statement

Breakeven point (@15%) = Fixed costs / CM Ratio

= $ 4,800,000 / 0.4
= $ 12,000,000
b. When commission rate is increased to 20%
Based on below budgeted income statement

Breakeven point (@20%) = Fixed costs / CM Ratio

= $ 4,800,000 / 0.35
= $ 13,714,286

c. When company employs its own sales force

Breakeven point (@7.5%) = Fixed costs / CM Ratio

= $ 7,125,000 / 0.475
= $ 15,000,000
2. Determine the volume of sales that would be required to
generate the same net income as contained in the budgeted
income statement for next year. (@20%)
Dollar sales to attain target = (Fixed expenses + Target income before
taxes) / CM Ratio
= ($4,800,000 + $1,600,000)/ .35
= $18,285,714

3. Determine the volume of sales at which net income would be

equal regardless of whether pittman company sells through
agents or employ its own sales force
X= TOTAL SALES REVENUE
0.65X + $4,800,000 = 0.525X + $7,125,000
0.125X = $2,325,000
X = $2,325,000 / 0.125
X= $18,600,000

4. Compute the degree of operating leverage that the company

would expect to have on Dec 31 at the end of next year
assuming:
a. The agents commission rate remains unchanged at 15%
Degree of Operating Leverage = CM/Net income
DOL= $6,400,000 / $1,600,000
DOL= 4
b. The agents commission rate is increased to 20%
Degree of Operating Leverage = CM/Net income
DOL= $ 5,600,000 / $800,000
DOL= 7
c. The company employs its own sales force.
Degree of Operating Leverage = CM/Net income
DOL= $7,600,000 / $475,000
DOL= 16

V.

CONCLUSION (answer to question 5)

Based on the data in 1 to 4 above make a recommendation as to whether
the company should continue to use sales agents (at a 20% commission
rate) or employ its own sales force. Give reasons for your answer.
Answer: We would continue to use the agents for at least one more
year, and possibly for two more years because
a. First, use of the sales agents would have a less dramatic effect on
net income.
b. Second, use of the sales agents for at least one more year would
give the company more time to hire competent people and get the
sales group organized.
c. Third, the sales force plan doesnt become more desirable than the
use of sales agents until the company reaches sales of $18,600,000
a year
d. Fourth, the sales force plan will be highly leveraged since it will
greatly increase fixed costs (and decrease variable costs).

VI.

RECOMMENDATION
It is important you analyze every item of the financial statements and
to make a statement out of financial analysis of these statements. Not
because it appears that you could eliminate cost on one item means that
it would already be a good decision. Opportunity cost must be considered
and also the cost-benefit.
Moreover, it is essential to compute the degree of operating leverage
to know how stable the company would be. The higher the degree of
operating leverage means the more unpredictable the company is; slight
change can greatly affect your companys performance.

APPENDIX
The budgeted income statement at 20% commission rate and same net
income as of 15%

The comparative statement at 15%, 20% and 7.5% commission rate at breakeven

Commission rate
Sales
Manufacturing
Commissions
Total variable expenses
Contribution Margin

15%
18,600,0
00
9,410,00
0
2,790,00
0
12,200,0
00
6,400,00
0

20%
18,600,0
00
8,480,00
0
3,720,00
0
12,200,0
00
6,400,00
0

7.50%
18,600,0
00
8,480,00
0
1,395,00
0
9,875,00
0
8,725,00
0

2,340,00
0
120,000

2,340,00
0
120,000

2,340,00
0
2,520,00
0

Less fixed expenses

Manufacturing overhead
Marketing

Administrative
Interest
Total fixed expenses
Income before income taxes
Income taxes
Net income

1,800,00
0
540,000

1,800,00
0
540,000

1,725,00
0
540,000

4,800,00
0
1,600,00
0
480,000

4,800,00
0
1,600,00
0
480,000

7,125,00
0
1,600,00
0
480,000

1,120,00
0

1,120,00
0

1,120,00
0