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 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

Fixed expenses:

2. For each expense that is variable with respect to revenue hours, calculate the cost per revenue hour. Jan 1,546 7,896 9,442 329 $ 28.70 $ 0.03 $ $ $ Feb 1,485 7,584 9,069 316 $ 28.70 $ 0.03 $ $ $ Mar 1,697 8,664 10,361 361 28.70 (costs/hours) 0.03 (hours/costs)

Power Op: hourly personnel Total Variable Costs Total Revenue Hours Var. Costs per Rev. Hour Var. Cost per Rev. Hour. Breakdown

$ $ $ $ $

Power per revenue hour Op: hourly personnel per revenue hour

= =

$ $

4.70 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 Commercial Total Revenues Less Variable Expenses Contribution Margin Fixed Expenses Rent

$ 82,000 =$400/hour * 205 hours $ 110,400 =$800/hour * 138 hours $ 192,400 $ 9,844 =$28.70 * (205 hours + 138 hours) $ 182,556 $ 8,000

Custodial services Computer leases Maintenance Dep:comp equip Dep:office equp. & fixt. Op:salaried staff Sys. devel. & maint. Administration Sales Sales promotion Corporate services Total Expenses Net Income

$ 1,240 $ 95,000 $ 5,400 $ 25,500 $ 680 $ 21,600 $ 12,000 $ 9,000 $ 11,200 $ 8,083 $ 15,236 $ 212,939 $ (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 = Commercial hours = Commercial rate = Commercial hours =

$800 / hour 138 1000 / hour (increased by $200) 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 = Commercial hours = 600 / hour 179.4 (decreased by $200) (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 = Commercial hours = 800 / hour 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