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SALEM TELEPHONE COMPANY

FIXED EXPENSES Vs VARIABLE EXPENSES


Power and Operations: hourly personnel are variable costs that have relation to the total revenue hours. Fixed Costs: Rent, Depreciation, Maintenance, Salaried stuff. Infact, all other expenses listed in Exhibit 2 are all fixed costs.

VARIABLE COST PER REVENUE HOUR


January February March

Power Operations: hourly personnel Total variable costs Total revenue hours Variable costs per revenue hour

1,546 7,896 9,442 329 28.70

1,485 7,584 9,069 316 28.70

1,697 8,664 10,361 361 28.70

CONTRIBUTION MARGIN INCOME STATEMENT


Furthermore, by distinguishing the variable costs and fixed costs, we can construct the contribution margin income statement for SDS at March level, assuming 205 hours for intra company usage:

Revenues
Intracompany (400 x 205) Commercial (800 x 138) Total Revenues Variable expenses (power + hourly person) Contribution margin Fixed expenses Rent Custodial services Computer leases Maintenance Depreciation Salaried staff System development Administration Sales Sales promotion Corporate services Total fixed expenses Net income 82,000 110,400 192,400 9,844 182,556 212,939 8,000 1,240 95,000 5,400 26,180 21,600 12,000 9,000 11,200 8,083 15,236 212,939 -30,383

LEVEL OF COMMERCIAL REVENUE HOURS OF COMPUTER USE TO BREAK EVEN


First of all we have to calculate the portion that the intracompany sales cover of the fixed costs. Sale revenue per Unit (a) $ 400.00 Variable cost per Unit (b) $ 28.70

Intracompany sales (a x 205) $ 82,000.00 Variable costs (b x 205) ($ 5,883.50) Contribution margin $ 76,116.50 We can see from the Exhibit the intracompany sales of hours give us a contribution margin of $ 76,116.50 which means that they are covering this amount of the fixed cost.

Total fixed cost Fixed cost covered by intracompany sales Fixed cost remaining

$ 212,939.00 ($ 76,116.50) $ 136,822.5

To reach break-even we need to sell that number of commercial hours to cover, beside the variable cost, the amount of $ 136,822.50 of fixed cost. To calculate this we are using the following equation: (205 400 + x 800) 28.7 (205 + x) 212939 = 0 82000 + 800x 5884 28.7 x 212939 = 0 x = 178 Therefore, SDS needs to serve at least 178 commercial hours to break even

EFFECT ON INCOME: PRICE STRATEGY & PROMOTION STRATEGY


According to Flores suggestion, if commercial price is increased to $1000, the demand reduces 30%, then the effect on net income will be: x = 138 (1 0.3) 97 (205 400 + 97 1000) 28.7 (205 + 97) 212939 = 42606

On the other hand, if the commercial price is reduced to $600, the demand increases 30%. The result of net income will be:

x = 138 (1 + 0.3) 180 (205 400 + 180 600) 28.7 (205 + 180) 212939 = 33989 Another suggestion is to increase 30% commercial hours by increasing sales promotion. In such way, the extra costs from promotion should not exceed: x = 138 (1 + 0.3) 180 (205 400 + 180 800) 28.7 (205 + 180) 212939 = 2012

IS SDS REALLY A PROBLEM TO STM ?


Two approaches suggested by Flores: 1) Use pricing strategy to increase commercial revenue hours This method will not add extra costs. However, according to our estimation above, changing price to either $1000 (97 hours) or $600 (180 hours) cannot prevent a net loss. 2) Increase sales promotion cost to win more business but the price unchanged If SDS wants to increase 30% of commercial sales, the extra promotion costs cannot be exceed $2012. Considering the promotion cost $8083 on March, additional $2012 is roughly 24.9%. That is, SDS can only increase 25% promotion cost to achieve 30% of growth.

Fixed expenses
Rent 8,000

Maintenance
Power Salaried staff Hourly personnel System development

5,400
1,697 21,600 8,664 12,000

Administration
Sales Sales promotion Total saved expenses Outsourcing costs

9,000
11,200 8,083 85,644 164,000

Extra cost if close SDS

-78,356

STC can only save $85644 by closing SDS, but it needs to spend $164000 to purchase service from outside. In other words, STC needs to pay extra $78356 if SDS does not exist. Therefore STC should keep SDS business. Since SDS is essential to keep, the first priority of SDS goal is to break even, at least. We recommend Cynthia Wu to combine both Flores suggestions. That is, both increase the promotion budget and also reduce price, which will make SDS become profitable more easily.

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