Summary Prestige Data Services is a subsidiary of Prestige Telephone Company, designed to perform data processing for the telephone company and also to sell computer services to other companies and organizations.
The subsidiary started operations in 1995 and has yet to experience a profitable month and by the end of 1996 its income was low enough to necessitate a report to shareholders. Mrs. Bradley thinks the company just needs more time while Mr. Rowe feels it is time to reassess Prestige Data Services. Mr. Rowe believes it is possible the accounting reports do not reveal the contribution the Data Service has provided and also the accounting for separate activities may obscure the costs and benefits provided. Therefore we have used the exhibits provided to analyze and come to a conclusion whether Prestige Data services should be shut down or allowed more time to show its contribution.
Analysis 1) The first thing we noticed is that fixed and variable costs are included in the report. However, variable costs are the only costs that should be considered when making decisions. It is also important to look at the opportunity cost of the leases for the computer equipment, which had four years left and are noncancelable. The purpose of the company was to provide a step towards deregulation and would decrease the need for a rate increase. Also if they shut down Data Services they would have to pay an outside company to provide this service to Prestige Telephone
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Company along with lose the revenue from the commercial sales. In regards to the space that Prestige Data uses, they could potentially rent the out the space to an outside company. There would also be a benefit to laying the personnel off and not having to pay those wages and salaries.
However, we came to the conclusion that Prestige Data Services is more of a benefit than Rowe initially thought and should be given more time to show its contribution. 2) In order to determine the level of commercial sales of computer use necessary to break In order to determine the level of commercial sales of computer use necessary to break even, we had to determine fixed and variable costs. The only variable costs were power and part of operations salaries. We found the unit contribution margin, which is selling price minus variable cost per unit. Total power for all three months is $5,028 divided by the hours the computer was in use (total hours – available hours), 1110 for a result of $4.53. Operations salaries paid hourly was found by taking total operations expense of $88,944 divided by 1110 (hours of computer use) for a result of $80.13. Contribution margin:
(800-4.53-80.13) = $715.34 Prestige Telephone Company has an agreement with the Prestige Service Commission (PSC) to cover $82,000 of the costs. Using this assumption and that mentioned in the above paragraph, we made the following break even analysis:
(FC) – [(PSC restriction) – (avg monthly hrs x VC/unit)] Contribution Margin FC= (9240+95000+5400+25500+680+12000+9000+11200+7677+15340) = 191,037 191,037 – [(82,000 – (205 x 84.66)]
= 176.69 hours
715.34 Taking the 176.69 hours times the $800 per hour for commercial sales would result in a break even revenue of $141,532 that would be necessary each month. 3) a) Increasing the price to commercial customers to $1,000 per hour would reduce demand by 30%.
Month hrs * 0.7 Price $1,000 Jan Feb Mar Hrs 86.1 94.4 96.6 CM $70,955.87 $77,688.45 $80,771.12 Current $76,765.53 $87,787.32 $87,787.32 The monthly contribution to fixed costs and income at $800 is greater than the contribution expected at $1,000. Thus, we will get more income if we maintain the present $800/hour price. b) Reducing the price to commercial customers to $600 per hour would increase demand by 30%. Month hrs * (1+0.3) Jan Feb Mar Hrs 98.4 91.8 110.4 CM $61,412.42 $67,186.80 $70,229.86 Current $76,765.53 $87,787.32 $87,787.32 Compared to present contribution, a price reduction would apparently reduce profit. So we still should maintain current operation. c) An increase in promotion that would increase commercial sales by 30%.
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Month hrs * (1+0.3) Jan Feb Mar Hrs 159.9 9108 110.4 CM $99,795.19 $67,186.80 $70,229.86 Current $76,765.53 $87,787.32 $87,787.32 Spec. Inc $23,029.66 $25,195.05 $26,336.20 Substract the present contribution, $76560.91could be spent without reducing income. d) Reducing operations to 16 hours on weekdays and eight hours on Saturdays would result in a loss of 20% of commercial revenue hours. Month hrs * 0.8 Jan Feb Mar
Hrs 98.4 CM $61,412.42 Current $67,186.80
108 110.4 $76,765.53 $70,229.86 $83,983.50 $87,787.32
Reducing operation hours does not mean a reduction in fixed costs which are way above the amount of revenue Prestige Data Services is making. Cutting down the working hours will mean a huge loss beyond what is being witnessed at the current working hours which makes this a bad idea to forge forward with.
4) Prestige Data Services should show consolidated financials for the parent and sub companies so it shows the true contribution the Prestige Data is providing for Prestige Telephone Company. There are certain costs within Prestige Data that benefit the parent company, but are only being seen as an expense to Prestige Data and not showing these services providing revenue for Prestige Telephone Company. They should also realize that when making decisions variable costs are the costs to consider and not just all reported costs.
