CVP Comprehensive Problem
Gupta Travel is a charter airline service for corporate clients traveling between Atlanta and Boston. The company leases one jet aircraft and flies an average of 150 one-way trips per year. Gupta’s marketing strategy is to sell a more enjoyable travel experience than its rivals in the commercial airline industry. Gupta arranges ground transportation in Atlanta and Boston for its clients, offers a more spacious cabin with larger seats and more legroom, and serves gourmet meals on its flights. Gupta does not sell its services to individuals; rather its services are marketed directly to corporate clients. Therefore, when Gupta books a flight for a client, it is not merely selling a few seats on its aircraft. Rather, the corporate client is booking the use of the aircraft for its travel needs. Gupta uses a network of commissioned travel agents to sell its services. These agents are not employees of Gupta, and the agents receive a 20 percent commission (no fixed salary) on each flight sold on Gupta Travel.
Gupta had the following income statement for the year ending December 31, 2014.
For the Year Ending 12/31/2014
Sales Revenue (150 one-way flights _ $40,000 per flight) $6000,000
Commissions Expense (20 percent of Sales Revenue) 1,200,000
Annual Lease Expense—Airplane 1,000,000
Annual Fee for Airport Ground Crew Services 800,000
Flight Crew Expense (150 one-way flights _ $1,500 per flight) 225,000
Fuel Expense (150 one-way flights _ $1,000 per flight) 150,000
Food Expense (150 one-way flights _ $800 per flight) 120,000
Ground Transportation Expense (150 one-way flights _ $200 per flight) 30,000
Other Fixed General and Administrative Expenses 150,000
Operating Income 2,325,000
Fixed Interest Expense 230,000
Net Income 2,095,000
(1) Prepare the contribution margin Income Statement
(2) What is Gupta’s current breakeven point?
(3) At the end of 2013, Gupta’s management learned that its commissioned travel agents are
demanding an increase in their commission rate to 30 percent per flight for the upcoming
year. As a result, Gupta’s president has decided to investigate the possibility of hiring an
in-house sales staff to replace the commissioned travel agents. Gupta’s accounting department compiled the following information to be used to evaluate the cost of establishing an in-house sales department.
Costs of Establishing an In-House Sales Department
The accounting department estimates that Gupta would need to hire four salespeople at an
average payroll cost of $85,000 per employee to cover the workload of the current travel agents.
Also, in order to hire highly qualified individuals for these positions, the compensation package
must include commissions. To be competitive with the industry-standard commission rate, Gupta
must offer a 15 percent commission on each flight sold in addition to the salary. The cost of the in house sales department will also include travel costs and support staff. Travel and entertainment expense is expected to total $600,000 (fixed) for the year, and the annual cost of support staff positions will be fixed at $150,000. Gupta currently relies on the travel agents to sell its services. If Gupta were to replace its commissioned travel agents with an in-house sales department, then it would have to bear more of the cost of advertising its services. In order to maintain the company’s image and manage the transition from established travel agents to an in-house sales staff, the accounting department recommends spending $550,000 (fixed) annually on advertising.
Use the December 31, 2014 Income Statement (with 150 flights sold) to estimate Gupta’s
breakeven point in units (flights) if the company hires its own sales force and increases its
Based on your answer, what amount of sales revenue would the company
generate at this breakeven point?
(4) Assume that Gupta decides not to hire its own sales force, but instead consents to give its
current commissioned travel agents the raise they are demanding. How many flights must the company sell (with the new commission rate) to generate the same net income that was
reported in 2014?
(5) Management must choose between: (a) hiring its own sales force and (b) compensating its
current network of travel agents with a higher commission rate.
(i ) What is the profit formula for alternative (a), hiring an in-house sales force?
(ii ) What is the profit formula for alternative (b), increasing the commission rate of the
current travel agents?
(iii ) At what level of sales volume (in flights) would management be indifferent between
these two alternatives? (Indifference means the sales volume [units] that would
produce the same profit between the alternatives.)
(5) Based on your calculations in (1)–(4), which alternative would you recommend to
Gupta’s management? Briefly explain your answer.
|Due By (Pacific Time)||09/16/2015 12:00 am|
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