1.

"Revenue hours" represent the key activity that drives costs at Salem
Data Services. Which expenses in Exhibit 2 are variable with respect to
revenue hours? Which expenses are fixed with respect to revenue hours?

Variable expenses: Power

Operations: hourly personnel

Fixed expenses: Rent

Custodial services
Computer leases
Maintenance
Dep: Computer equipment
Dep: Office equipment and fixtures
Operations: salaried staff
Systems development and maintenance
Administration
Sales
Sales promotion
Corporate services

2. For each expense that is variable with respect to revenue hours, calculate
the cost per revenue hour.

Jan Feb Mar

Power $ 1,546 $ 1,485 $ 1,697
Op: hourly personnel $ 7,896 $ 7,584 $ 8,664
Total Variable Costs $ 9,442 $ 9,069 $ 10,361
Total Revenue Hours 329 316 361
Var. Costs per Rev. Hour $ 28.70 $ 28.70 $ 28.70 (costs/hours)
Var. Cost per Rev. Hour. $ 0.03 $ 0.03 $ 0.03 (hours/costs)

Breakdown

Power per revenue hour = $ 4.70

Op: hourly personnel per revenue hour = $ 24

3. Create a contribution margin income statement for Salem Data Services.

Assume that intracompany usage is 205 hours. Assume commercial usage
is at the March level.

Revenues
Intracompany $ 82,000 =$400/hour * 205 hours
Commercial $ 110,400 =$800/hour * 138 hours
Total Revenues $ 192,400
Less Variable Expenses $ 9,844 =$28.70 * (205 hours + 138 hours)
Contribution Margin $ 182,556
Fixed Expenses
Rent $ 8,000
 Custodial services $ 1,240
Computer leases $ 95,000
Maintenance $ 5,400
Dep:comp equip $ 25,500
Dep:office equp. & fixt. $ 680
Op:salaried staff $ 21,600
Sys. devel. & maint. $ 12,000
Administration $ 9,000
Sales $ 11,200
Sales promotion $ 8,083
Corporate services $ 15,236
Total Expenses $ 212,939
Net Income $ (30,383)

4. Assuming the intracompany demand for service will average 205 hours
per month, what level of commercial revenue hours of computer use
would be necessary to break even each month?

Total Revenues - Total Costs = Profit

Breakeven occurs when profit = $0

Total Revenues = ($400(intra rate)*205 hours) + ($800(comm. rate) * x hours)

=82000 + 800x

Total Costs = Fixed Costs + Variable Costs

= 212939 + 28.70 * (205 hours + x hours)
= 212939 + 5884 + 28.70x
=218823 + 28.70x

0 = 82000 + 800x - 218823 - 28.70x

0 = -136823 + 771.30x
x = 177.39 hours per month

5. Estimate the effect on income of each of the options Flores has suggested
if Wu estimates as follows:
a. Increasing the price to commercial customers to $1,000 per hour would reduce
demand by 30%.

(using March)
Commercial rate = $800 / hour
Commercial hours = 138

Commercial rate = 1000 / hour (increased by $200)

Commercial hours = 96.6 (decreased by 30%)

Profit = 82000 + 1000x - 218823 - 28.70x

Profit = -136823 + 971.30x
x = 96.6 hours
Profit = -$42,995
b. Reducing the price to commercial customers to $600 per hour would increase
demand by 30%.

Commercial rate = 600 / hour (decreased by $200)

Commercial hours = 179.4 (increased by 30%)

Profit = 82000 + 600x - 218823 - 28.70x

Profit = -136823 + 571.30x
x = 179.4 hours
Profit = -$34,332
Increased promotion would increase revenue hours by up to 30%. Wu is unsure
c. how much promotion this would take. (How much oculd be spent and still leave
Salem Data Services with no reported loss each month if commercial hours were
increased 30%?)

Commercial rate = 800 / hour

Commercial hours = 179.4 (increased by 30%)

Profit = 82000 + 800x - 218823 - 28.70x

Profit = -136823 + 771.30x
x = 179.4 hours
Profit = $1,548 maximum amount that could be spent on advertising
without any reported loss for the month

6. Based on your analysis above, is Salem Data Services really a problem to

Salem Telephone Company? What should Flores do about Salem Data
Services?
For the last three years Salem Data Services (SDS) has operated in the red and
over the last three months net income has been just under breakeven. Should Wu
suggest option A or B my analysis shows that net income will still be negative by
tens of thousands of dollars. Analysis on option C does report a positive net
income but would only leave about $1,500 for the marketing promotion before
breakeven - not even a quarter of their current marketing budget ($8083) and
hardly enough to reach the desired outcome of a 30% increase in revenue hours.

Therefore the question is this: how much money is Salem Telephone Company
saving in expenses by keeping SDS as a subsidiary? Should they decide to sell or
close SDS they would have to purchase data services at a standard rate of
$800/hour for an average monthly expense of $164,000 (800*205). Many of
SDS's expenses were shared by Salem Telephone company and should they
choose not to operate the subsidary they would save only about $85,000 in
expenses (see table below). So the $85,000 they save by ridding themselves of
SDS would not get anywhere close to covering their new bill of $164,000 for data
services.
Peter Flores should keep SDS open under the company's current performance. Of
course changes need to be made that lead toward a positive net income. Therefore
I recommend prices be decreased (option B showed better results than option A)
and promotions be increased as much as is feasible. Both together will hopefully
yield large increases in commercial hours sold.

SDS costs (potential to be saved)

Rent $ 8,000 (assuming it is easily rented out)
Maintenance $ 5,400
Power $ 1,697
Op:salaried staff $ 21,600
Op:hourly staff $ 8,664
Sys. devel. & maint. $ 12,000
Administration $ 9,000
Sales $ 11,200
Sales promotion $ 8,083
Total Expenses $ 85,644