Salem Telephone Company Case
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Salem Telephone Company Salem Telephone Company decided to start a computer data service subsidiary to perform data processing for telephone companies and sell computer service to other companies. However in 2003 this subsidiary’s performance was poor and the return on investment was the lowest according to all years’ financial report. The president wanted to reassess this subsidiary and provided its quarterly report for consideration. According to the given Exhibit 2, all expenses can be put into two categories: variable expense and fixed expense. The variable expense includes the power and the wage for personnel. The rest all expenses are included in the fixed expense. The following Exhibit A shows the detail for these two expense categories. [pic 1] The sales promotion and corporate services in the Fixed Expense category are two expenses whose numbers are different in each month. But as these expenses are not influenced by how much unit sold, we consider them to be fixed expenses. After having the variable expenses and the total revenue hours, we can calculate the variable cost per revenue hour. The Exhibit B shows the variable cost per revenue hour for the power and wage for personnel.[pic 2] The ratio got from Exhibit B will be used to calculate the total variable for each month. According to the president’s requirement, we generate the contribution margin income statement for March. The following Exhibit C shows the number details.[pic 3] Because the intracompany’s hour is 205 instead, its sales is calculated as 205*$400=$82,000. And the total variable cost will be changed to 9844.385 which is calculated as $28.7*(205+138). By looking at this income statement, we find that it has a negative net income. If the subsidiary wants to break even and have the intracompany sale remains 205 hours, the commercial sale would need to be 177.39 hours. The calculation is shown as followed:
212,939= ($400-$28.7)*205= ($800-$28.7)*X 136,822.5=771.3X X=177. 39 But the commercial sale in March is 138 hours which is much lower than the break even needs. The manager comes up with three assuming options and wants to see which one of the three can be profitable. The following Exhibit D shows the contribution margin and total income for these three options.Exhibit DCurrent situationOption 1Option 2Option 3Total Revenue192,400178,600189,640225,520Total Variable Expense9,8448,65611,03311,033Contribution Margin182,556169,944178,607214,487Total Fixed Expense212,939212,939212,939212,939Net Income-30,383-42,995-34,3321,548 The first option requires an increase of commercial sale price from $800 to $1000. Meanwhile the total commercial hour sold will be decreased by 30%. This will change the total revenue into $400*205+ $1000*138* (1-30%) = $178,600 However, its total income is $12,612 lower than the current income. This means option 1 is less profitable and should not be considered.