Marston 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 sell a variety of products to hospitals in addition to Marston’s disposable thermometer. The sales agents are currently paid an 18% commission on sales, and this commission rate was used when Marston’s management prepared the following budgeted absorption income statement for the upcoming year.

$$\begin{array}{c} \hspace{90pt}\textbf{Marston Corporation}\hspace{90pt}\\ \textbf{Budgeted Income Statement}\\ \end{array}$$

$$\begin{array}{lrr} \text{Sales}&&\$\hspace{5pt}\text{30,000,000}\\ \text{Cost of goods sold:}\\ \hspace{10pt}\text{Variable}&\$\hspace{5pt}\text{17,400,000}\\ \hspace{10pt}\text{Fixed}&\underline{\hspace{14pt}\text{2,800,000}}&\underline{\hspace{10pt}\text{20,200,000}}\\ \text{Gross margin}&&\text{9,800,000}\\ \text{Selling and administrative expenses:}\\ \hspace{10pt}\text{Commissions}&\text{5,400,000}\\ \hspace{10pt}\text{Fixed advertising expense}&\text{800,000}\\ \hspace{10pt}\text{Fixed administrative expense}&\underline{\hspace{14pt}\text{3,200,000}}&\underline{\hspace{15pt}\text{9,400,000}}\\ \text{Net operating income}&&\underline{\underline{\$\hspace{18pt}\text{400,000}}}\\ \end{array}$$

Since the completion of the above statement, Marston’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, Marston’s management has decided to investigate the possibility of hiring its own sales staff to replace the independent sales agents.

Marston’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 Marston, management believes that the company’s bu get for fixed advertising expenses should be increased by$500,000.

Required:

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.

2. Calculate Marston 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.

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)?

4. Determine the volume of sales at which net operating income would be equal regardless of whether Marston Corporation sells through agents (at a 20% commission rate) or employs its own sales force.

5. Prepare a graph on which you plot the profits for both of the following alternatives.

a. The independent sales agents’ commission rate increases to 20%.

b. The company employs its own sales force.

On the graph, use total sales revenue as the measure of activity.

6. Write a memo to the president of Marston Corporation in which you make a recommendation as to whether the company should continue to use independent sales agents (at a 20% commission rate) or employ its own sales force. Fully explain the reasons for your recommendation in the memo.

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