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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.)

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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