Liam Hennessy, Xinyi Zhang, Yuan Chai, and Anthony Saba
1. Reasons for Continuing Losses
Prestige Data Services’ main problem is that they have too many available hours that are not generating any revenue. In the first quarter of 2003, they have an average of 176 available hours per month of available hours. Its operations exact a huge amount of fixed costs to cover. If they could find more commercial customers for the available capacity, they could increase their commercial sales revenue by as much as $140,880 (176*800). In addition, they are also creating unnecessary expenses by having to pay all kinds of expenses during these unprofitable hours.
2. Breakeven Point of Commercial Sales & Evaluation of the Suggested Options (Questions #2 and #3 attached to the case)
Before starting to answer these two questions, it is more than necessary that we get the formula for Prestige Data Services’ net income (loss), even they will not be very exact.
If we combine the data in each category in Exhibit 2 (such as Intercompany sales, Rent, and Operations, etc.) as a whole, and let a = Intercompany revenue hours, and b = Commercial revenue hours, then we can derive the following revenue and cost formulae of Prestige Data Service in each month:
Intercompany revenues = $400a
Commercial revenues = $800b Total revenues = $400a+$800b+$0.055(400a+800b) Other revenues = $0.055(400a+800b) = $ 1.055(400a+800b)
*0.055 = (9,241+9,184+12,685) / (190,041+189,584+212,285)
ii. Fixed costs
Space costs = Rent + Custodial services = 8,000 +1,240 = $9,240 Equipment costs = Computer leases + Maintenance = 95,000 +5,400= $100,400 Depreciation = 25,500+680= $26,180
Fixed wages and salaries = System development and maintenance + Administration + Sales = 12,000 +9,000+11,200 = $32,200
* Total fixed costs = $ 168,020
iii. Variable costs
Power = $5(a + b)
Sales promotion = $22.9(a + b) Total variable costs = $55.8(a + b) Materials = $27.9(a + b)
*5 = (1,633+1,592+1,803) / (329+316+361)
*22.9 = (7,909+7,039+8,083) / (329+316+361)
*27.9 = (9,031+8,731+10,317) / (329+316+361)
iv. Mixed Costs
Using the high-low method, we can get the approximate formula for operations cost: Operations = $21,600+24(a + b)
Since the amount of corporate services is paid based on wages and salaries each month, we can find that: Corporate services = $0.25*Wages and salaries = 0.25(Fixed wages and salaries + Operations) = 0.25[32,200+21,600+24(a + b)] = $13,450+$6(a + b)
* Total mixed costs =$35,050+ $30(a + b)
v. Net income (loss) = Revenues - Variable costs - Fixed costs - Mixed costs = 1.055(400a+800b) -168,020 -55.8(a + b) -35,050-30(a + b) = 1.055(400a+800b)-85.8(a + b) -203,070
With the formula worked out, now we are prepared to answer the questions.
Assuming the company demand for service will average 205 hours per month, what level of commercial sales of computer use would be necessary to break even each month?
When a = 205 hours, in order to break even, i.e. net income = $0, commercial sales hours (b) = (203,070-336.2*205)/758.2= 177 hours
Estimate the effect on income of each of the options Rowe has suggested
Option # a: Increase the price to commercial customers to $1,000 per hour would reduce demand by 30%.
In this option, 800 will be replaced by 1,000 and b by 0.7b, then: Net income (loss) = 1.055(400a+700b)-85.8(a + 0.7b) -203,070=336.2a+678.44b-203,070
Therefore, the adoption of option # a will decrease the net income.
Option # b: Reducing the price to commercial customers to $600 per hour would increase demand by 30%.
In this option, 800 will be replaced by 600 and b by 1.3b, then: Net income (loss) = 1.055(400a+780b)-85.8(a + 1.3b) -203,070=336.2a+711.36b-203,070
Therefore, the adoption of option # b will reduce the net income as well.
Option # c:...