Case study:
Hard Rock Corporation manufactures disposable thermometers that are sold to hospitals through a network of independent sales agents located in the United States and Canada. These sales agents sells a variety of products to hospitals in addition to Hark Rock’s disposable thermometer. The sales agents are currently paid an 18% commission on sales, and this commission rate was used when Hard Rock’s management prepared the following budgeted income statement for the upcoming year.
Since the completion of the above statement, Hard Rock’s management has learned that the independent sales agents are demanding an increase in the commission rate to 20% of sales for the upcoming year. This would be the third increase in commissions demanded by the independent sales agents in five years. As a result, Hard Rock’s management has decided to investigate the possibility of hiring its own sales staff to replace the independent sales agents.
Hard Rock’s controller estimates that the company will have to hire eight salespeople to cover the current market area, and the total annual payroll cost of these employees will be about $700,000, including fringe benefits. The salespeople will also be paid commissions of 10% of sales. Travel and entertainment expenses are expected to total about $400,000 for the year. The company will also have to hire a sales manager and support staff whose salaries and fringe benefits will come to $200,000 per year. To make up for the promotions that the independent sales agents had been running on behalf of Hard Rock, management believes that the company’s budget for fixed advertising expenses should be increased by $500,000.
Question 1: Assuming sales of $30,000,000, construct a budgeted contribution format income statement for the upcoming year for each of the following alternatives:
a) The independent sales agents’ commission rate remains unchanged at 18%.
b) The independent sales agents’ commission rate increases to 20%.
c) The company employs its own sales force.
Question 2: Calculate Hard Rock Corporation’s break-even point in sales dollars for the upcoming year assuming the following:
a) The independent sales agents’ commission rate remains unchanged at 18%.
b) The independent sales agents’ commission rate increases to 20%.
c) The company employs its own sales force.
Question 3: Refer to your answer to (1)(b) above. If the company employs its own sales force, what volume of sales would be necessary to generate the net operating income the company would realize if sales are $30,000,000 and the company continues to sell through agents (at a 20% commission rate)?
Question 4: Determine the volume of sales at which net operating income would income would be equal regardless of whether Hard Rock corporation sells through agents (at a 20% commission rate) or employs its own sales force.
Question 5: Prepare a graph on which you plot the profits of both of the following alternatives.
a) The independent sales agents’ commission rate increases to 20%.
b) The company employs its own sales force.