You work as a Manager for Happy Kids Ltd, a company that manufactures toys, infant products and electronic games. These products are sold through sub-contracted Sales Agents, who currently earn a commission of 17% on sales.
The following is the most recent set of Management Accounts you have received from the Accountant:
for the year ended 30 June 2016
|Cost of goods sold||$ 17,910,000|
|GROSS PROFIT||$ 18,090,000|
|Selling and admin costs||$ 10,245,000|
|Variable sales commissions||$ 6,120,000|
|Fixed advertising costs||$ 900,000|
|Fixed admin costs||$ 3,225,000|
|OPERATING INCOME||$ 7,845,000|
|Fixed interest expenses||$ 1,200,000|
|PROFIT BEFORE TAX||$ 6,645,000|
|Income tax||$ 1,777,500|
|NET PROFIT AFTER TAX||$ 4,867,500|
The sub-contracted Sales Agents are pushing your company for an increase in the commission rate from 17% to 20% for the year ending 30 June 2017. Because of this, the CEO would like to investigate the possibility of hiring its own internal Sales Team rather than continuing to use sub-contracted Sales Agents.
The Accountant has summarised the cost estimates for employing an internal Sales Team, which would consist of a Sales Manager, a Personal Assistant, and five Sales Representatives:
- The cost of hiring a Sales Manager would be fixed at $150,000 per year (including all on-costs).
- The cost of hiring a Personal Assistant would be fixed at $50,000 per year (including all on-costs).
- Travel and entertainment costs that will be incurred by the Sales Team are expected to be fixed at $340,000 per year.
- Additional advertising costs (TV commercials) will be fixed at $350,000 per year.
- The five Sale Representatives would have an annual fixed salary component of $80,000 each (including all on-costs).
- In addition to their fixed salary component, the Sales Representatives will be allowed to earn a variable Sales Commission as follows:
- 16% on their first $5 million in sales, followed by
- 19% on all of their sales over $5 million.
- Expected benchmarks are:
- all five Sales Representatives will exceed their first $5 million threshold, and the level of sales for next year (2017) is expected to be $38 million total.
1. CVP analysis
2016 data analysis
- What was the break-even level of sales (in $, not units) for 2016? (7 Marks) 2017 projections — sub-contract Sales Agents with increased commission
- If Happy Kids Ltd continues to use the sub-contracted Sales Agents and pays the higher sales commission rate of 20%, what is the estimated sales value that would be required for 2017 to generate the same profit (before tax) as achieved in 2016? Assume all fixed costs are the same as (Hint: Adjust the contribution margin you calculated in part a) (8 Marks)
2017 projections — employ internal Sales Team
- Using the estimates supplied by the accountant, what variable costs and additional fixed costs would be incurred if an internal Sales Team was employed in 2017? (13 Marks)
- Using the data from (c) above, if Happy Kids Ltd employs the internal Sales Team, what is the estimated sales value that would be required for 2017 to generate the same profit (before tax) as achieved in 2016? Assume all fixed costs are the same as 2016 and the variable component of COGS is 34% of Sales. (14 Marks)
List and comment briefly on the general assumptions underlying break-even analysis that might limit its usefulness in this case. Are there any other factors that you would consider? Please use bullet points and keep your answer concise. (5 Marks)
Based on your analysis in part 1, should management proceed to employ an internal Sales Team or continue using the sub-contracted Sales Agents in 2017? Give reasons. (3 marks)
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