Prestige Telephone Company
Prestige Telephone Company
1.Identify the costs that are relevant to the analysis to discontinue Prestige Data Services: Relevant costs in the analysis by Prestige Telephone Company decision to discontinue Prestige Data Services include: fixed costs which must be absorbed by the parent company (Prestige Telephone) upon shutdown; outstanding Prestige Data Services debts; costs of retraining retained employees; costs associated with outsourcing data services previously provided by Prestige Data Services; opportunity cost of using space rented to Prestige Data Services; marketing costs attributed to acquiring additional Prestige Data Services customers; costs of increasing promotional activities of Prestige Data Services. In addition, Prestige Telephone Company should consider the qualitative cost of reduced employee morale which may result upon shutdown of Prestige Data Services.
2.Justify why each of the costs in item 1 is relevant:
The costs listed above are all relevant because they each vary with the shutdown decision.
● Fixed costs which must be absorbed by the parent company (Prestige Telephone) upon shutdown: Payroll, billing, collections, and other corporate services were provided by Prestige Telephone in return for an amount from Data Services based on wages and salaries. These fixed costs allocated to Prestige Data Services must now be accounted for by the parent company.
● Costs of retraining employees: If employees are retained by Prestige Telephone, wages and salaries that were previously incurred by the Data Services line will hit Prestige Telephone’s budget. Also, new skills will be required of employees retained by the company as well as accompanying training expenses.
● Costs associated with outsourcing data services previously provided by Prestige Data Services: Prestige Telephone will still require the services Prestige Data Services supply and thus will need to outsource them. Since Prestige Telephone was using a price cap based on estimated data usage in 1999, they were effectively getting discounted data service rates from the subsidiary. If Data Services is shut down, the company might incur much higher service expenses.
● The maintenance cost is relevant because if Data Services is shut down the company will no longer incur this costs, thus it needs to be considered as a cost the parent company can eliminate.
● Opportunity cost of using space rented to Prestige Data Services: If Prestige Telephone decides to shut down the Data Services Company, the parent company will lose the $8000 monthly rental fee paid by the current subsidiary. Additionally, Prestige Telephone must consider the opportunity cost of renting the space to another company or service that may provide them with more income.
● If Prestige Data Services is shut down, marketing costs attributed to acquiring additional Prestige Data Services customers and promotional activities will no longer be necessary.
● Termination of Prestige Data Services employees as a result of shut down may reduce the morale of any retained employees or employees of the parents company. Prestige might experience decreased productivity or increased turnover as a result.
3.Identify the costs that are NOT relevant to the analysis to discontinue
Prestige Data Services: Costs not relevant to the decision are sunk costs such as the costs of training Prestige Data Service employees, investments in the IT infrastructure, and any owned Prestige Data Services Equipment. In addition, the fixed portion of the electricity costs is not relevant. Depreciation costs are also not relevant. The leases for computer equipment are non-cancelable and therefore may be considered sunk costs because Data Services is expected to cover the costs associated with the leases prior to being shutdown. However if Prestige Data Services is unable to pay off the leases, these costs will become relevant because the parent company, Prestige Telephone would be responsible for debts owed.
4.Justify why each of the costs in item 3 is NOT relevant
Fixed cost: Costs of equipment and fixtures are incurred whether or not Prestige Data Service continues to operate. Even if the subsidiary company is shut down, these fixed costs must still be taken into consideration. Some costs, such as electricity, whether used or not, will be charged for a certain basic amount every month and therefore should not be considered relevant. Depreciation is not relevant because cost of equipment is a sunk cost. There is no significant salvage value for the equipment.
5.Identify the revenues that are relevant to the analysis to discontinue Prestige Data Services: Revenues relevant to the analysis to discontinue the operation are commercial sales revenue which includes computer use and other.
6.Justify why the revenues in item 5 are relevant:
The revenues in item 5 differ across alternatives. In other words, these revenues are directly tied to Prestige Data Services. If the production capacity of Prestige Data Services decreases to zero, all the revenue resulting from these operations will also decrease to $0, which decreases the subsidiary’s contribution to its parent company.
7.Identify the revenues that are NOT relevant to the analysis to discontinue Prestige Data Services. The revenue of Prestige Telephone and the revenue from intercompany Sales are not relevant to the decision.
8.Justify why the revenues in item 7 are NOT relevant.
As we explained in item 6, all revenues from Prestige Data Services will change depending on the decision. As the production capacity is varied, all the revenues will vary. These changes show the expected overall effect on net income. Revenue at Prestige Telephone will not vary based on the decision to shut down Prestige Data Services because Prestige Telephone’s revenue is not tied to the operations of the subsidiary. From the perspective of the Parent Company, Intercompany Sales are a revenue stream for the subsidiary, but an equal cost to the Parent, thus it doesn’t affect the balance sheet of the parent company. 9.Is Prestige Data Services really a problem to the parent company. Justify your answer. Prestige Data Service is not a problem to the parent company. This is primarily because:
—Prestige Telephone will need to absorb Prestige Data’s relevant fixed costs.
—Prestige Telephone will have to pay higher rates for services previously provided by Prestige Data Services. Regardless of possible sunk costs such as equipment leases ($95,000), Prestige Data Service positively contributes to the parent company. Additionally, if Prestige Data Services were to charge Prestige Telephone the same rates ($800 per service hour) it charges for commercial services, the company would not be operating at a loss. If these commercial rates are considered competitive then the subsidiary is saving its parent money.
Furthermore, there are several strategies that can be implemented to increase the business value of Prestige Data Services, such as reducing computer usage.
10.Prepare monthly income statements for January, February, and March which support your answer to item 9.