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Calculating Profits based on Sales Commissions

Phatty Phun Corporation sells electronic games. Its three salespersons are currently being paid fixed salaries of $30,000 each; however, the sales manager has suggested that it might be more profitable to pay the salespersons on a straight commission basis. He has suggested a commission of 15% of sales.
Current data for Phatty Phun Corporation are as follows:

Sales volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15,000 units
Sales price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $40 per unit
Variable costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $29 per unit
Fixed costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $140,000

Required
a. Assuming that Phatty Phun Corporation has a target income of $50,000 for next year, which alternative is more attractive?
b. The sales manager believes that by switching to a commission basis, sales will increase 20%. If that is the case, which alternative is more attractive? (Assume that sales are expected to remain at 15,000 units under the fixed salary alternative.)

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Solution Preview

a. First we need to find out the sales level to get a target income of $50,000. The contribution margin per unit is 40-29=11 and the contribution margin ratio is 11/40=27.5%. The sales needed for a target net income of 50,000 are
(Fixed Cost + target net income)/Contribution margin ratio
sales ...

Solution Summary

The solution explains how to evaluate two alternatives by calculating the profits in both the cases.

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