Cortez Enterprises Is Studying the Addition of a New Product

Essay

Cortez Enterprises is studying the addition of a new product that would have an expected selling price of $180 and expected variable cost of $120. Anticipated demand is 9,000 units.
A new salesperson must be hired because the company's current sales force is working at capacity. Two compensation plans are under consideration:
Plan 1: An annual salary of $38,000 plus 10% commission based on gross sales dollars
Plan 2: An annual salary of $180,000 and no commission
Required:
A. What is meant by the term "operating leverage"?
B. Calculate the contribution margin and net income of the two plans at 9,000 units respectively.
C. Compute the operating leverage factor of the two plans at 9,000 units respectively. Which of the two plans is more highly leveraged? Why?
D. Assume that a general economic downturn occurred during year no. 2, with product demand falling from 9,000 to 7,200 units. By using the operating leverage factors, determine and show which plan would produce a larger percentage decrease in net income.