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Calculating Profits based on Sales Commissions

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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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Some questions

Hi. Here are some questions I'd like to compare the answers with.

1. A company sells regulators to other manufacturers who then customize and distribute the products to quality assurance labs for their sensitive test equipment. The yearly volume of output is 15,000 units. The selling price and cost per unit are shown below.
Selling Price $ 200
Costs:
Direct Material $ 35
Direct Labor 50
Variable Overhead 25
Variable Selling Expenses 25
Fixed Selling Expenses 15 150
Unit profit before tax $ 50

Management is evaluating the alternative of performing the necessary customizing to allow Electron Control to sell its output directly to Q/Q labs for $ 275 per unit. Although no added investment is required in productive facilities, additional processing costs are estimated as:
Direct labor $ 25 per unit
Variable overhead 15 per unit
Variable Selling Expenses 10 per unit
Fixed selling expenses $ 100,000 per year

Calculate the incremental profit Electron Control would earn by customizing its instruments and marketing directly to end users.

2. A furniture store sells hardwood chairs, in both kits and fully assembled forms. Customers who assemble their own chairs benefit from the lower kit price of $35 per chair. "Full-service" customers enjoy the luxury of an assembled chair, but pay a higher price of $ 60 per chair. Both kit and fully assembled chair prices are stable. The company has observed the following relation between the number of assembly workers employed per day and assembled chair output.

Number of Workers per Day Finished Chairs
0 0
1 5
2 9
3 12
4 14
5 15

A) Construct a table showing the net marginal revenue product derived from assembly worker employment.
B) How many assemblers would U-Do-It Furniture at a daily wage rate of $ 75?
C) What is the highest daily wage rate U-Do-It Furniture would pay to hire four assemblers per day?

3 Mr. Anthony Markins, owner-manager is reviewing the company's compensation plan. Currently, the company pays its three experienced management staff members salaries based on the number of years service. Chandler Bing, a new management trainee, is paid a more modest salary. Monthly sales and salary data for each employee are as follows:

Sales Staff Ave. Monthly Sales Monthly Salary
Monica Green $ 200,000 $ 12,000
Phoebe Buffay 150,000 9,750
Joey Tribbian 120,000 6,750
Chandler Bing 90,000 4,500

Bing in particular has shown great promise during the past year, and Green believes a substantial raise is clearly justified. At the same time, some adjustment to the compensation paid other sales personnel would also seem appropriate. Green is considering changing from the current compensation plan to one based on a 9% commission. Green sees such a plan as fairer to the parties involved and believes it would also produce strong incentives for needed market expansion.

a) Calculate Central Perk's salary expense for each employee expressed as a percentage of sales generated by that individual.
b) Calculate monthly income for each employee under a 9% compensation-based commission system.
c) Will a commission-based plan result in efficient relative salaries, efficient salary levels, or both?

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