Salem Telephone Company

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Salem Telephone Company-Case Study

Peter Flores, President of Salem Telephone Company, believes that a computer subsidiary company (Salem Data Services) appears to be unprofitable. And because of this, he must decide and determine whether it is actually unprofitable and consider whether changes in prices or promotion might improve profitability by using the Break-Even point analysis. But before we come out to any solutions, we must discuss Salem Data Services accounting report.

First, we have to divide the various costs incurred in Salem Data Services in two types: Variable costs and Fixed Costs. From Exhibit 2 we can see that only "Power" and "Operations: hourly personnel" are variable costs that have relation to the total revenue hours (Question 1). Other expenses listed in Exhibit 2 are all Fixed Costs.

Now we can calculate the unit of Variable Costs per Revenue Hours as follows-Question 2:

ExpensesJanuaryFebruaryMarch

Power $1,546 $1,485 $1,697
Operational hours-hourly personnel 7,896 7,584 8,664
Total Variable Costs $9,442 $9,069 $10,361
Total Revenue hours329316361
Variable Costs per Revenue hour $28.70 $28.70 $28.70

Furthermore, by distinguish the variable costs and fixed costs, we now can construct the contribution margin Income Statement for SDS at its March level, assuming 205 hours for Intercompany usage-Question 3

Income Statement
Revenues:
-Intracompany $82,000
-Commercial 110,400
Total Revenues 192,400

Variable Expenses:
-Power 1,697
-Hourly Personnel 8,147
Subtotal Variable Expenses 9,844
Contribution Margin 182,556

Fixed Expenses:
-Rent 8,000
-Custodial Services 1,240
-Computer Leases 95,000
-Maintenance 5,400
-Depreciation 26,180
-Salaried Staff 21,600
-System Development 12,000
-Administration 9,000
-Sales 11,200
-Sales Promotion 8,083
-Corporate Services 15,236
Total Fixed Expenses 212,939
Net Income/(Loss) (30,383)

Based on the above assumtions, we can obtain the number of commercial revenue hours as follows-Question 4:

IntercoDemanded Hrs
Fixed CostsRevenueCost($28.70 X 205 hrs)
$212,939 $(82,000) $5,883 = $136,822
$800 - $28.70 $771.30 178

Therefore, SDS needs to serve at least 178 commercial hours to break even

According to Peter Flores' suggestions, if commercial price is increased to $1,000, the demand reduces 30%, then the effect on Net Income will be-Question 5:

CommercialDemand
Revenue HrsReduce %SubtotalDiff
13830%41.4 97

(205 X $400 + 97 X $1,000) - 28.70 X (205+97) - $212,939 =($42,606)

On the other hand, if commercial price is reduced to $600, demand increases 30%, then Net Income will be

CommercialDemand
Revenue HrsIncrease %SubtotalDiff
13830%41.5 180

(205 X $400 + 180 X $600) - 28.70 X (205+180) - $212,939 =($33,989)

Another suggestion is to increase 30% commercial hours by increasing sales promotion. The extra costs will not exceed:

CommercialDemand
Revenue HrsIncrease %SubtotalDiff
13830%41.5 180

(205 X $400 + 180 X $800) - 28.70 X (205+180) - $212,939 =$2,012

What should Peter Flores do about Salem Data Services-Question 6:

1. Using price strategy to increase commercial revenue hours This method will not add extra costs. And according to the estimate above, changing price to either $1,000 for 97 hours or $600 for 180 hours can not prevent a net loss.

2. If SDS wants to increase 30% of commercial sales, the extra promotion costs can not exceed $2,012. Considering the promotion cost $8,083 on March, additional $2,012 is about 25%. That is, SDS can only increase 25% promotion cost to achieve 30% of growth.

Based on the analysis,...
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