Salem Telephone Company Case Study

Variable expenses:
Power (the more hours sold, the more energy consumed)
The hourly personnel (operations) works only when the computers are in operation

Fixed expenses:
The rent has to be paid despite any level of production ($8,000 monthly) The custodial services depend on Salem Telephone's estimated space, they are independent from the revenue of the Company The computer leases were acquired to run the business (before it was actually started up) The maintenance is necessary even when you do not produce/sell anything The deprecation depends on the number of years not on the number of hours sold Operations: salaried stuff consists of the six people necessary to run the center (the number of people remains the same) Systems development and maintenance the system needs to be developed and maintained constantly to keep the work in process Administration: the salaries are paid on a fixed regular basis Sales promotion: there is a certain amount of money that has been allocated on advertising Corporate services are independent from revenue (are obtained when needed) Sales (should equal an estimated amount)

Variable cost per revenue hour remains the same although the activity (the number of revenue hours) varies.

3. Variable cost per unit
Power $ 4.70 Operations: hourly personnel $ 24
Revenues $ 192,400 Intracompany sales ($ 400 x 205) $ 82,000
Commercial sales ($ 800 x 138) $ 110,400
Variable Cost ($ 9,844.1) Power ($ 4,7 x 343) ($ 1,612.10) Operations: hourly personnel ($ 8,232)
($ 24 x 343)
CONTRIBUTION MARGIN $ 182,555.90
Fixed Costs
Rent ($ 8,000)
Custodial Services ($ 1,240)
Computer leases ($ 95,000)
Maintenance ($ 5,400)
Depreciation Computer equipment ($ 25,500) Depreciation office equipment and fixtures ($ 680) Operations: salaried stuff ($ 21,600) Systems development and maintenance ($ 12,000) Administration ($ 9,000) Sales ($ 11,200) Sales promotion ($ 8,083) Corporate services ($ 15,236) ($ 212,939) Net Loss ($ 30,383.1)

The extent to which the intracompany sales cover of the fixed costs: Sale revenue per Unit $ 400
Variable cost per Unit $ 28.

70

Intracompany sales ($400 x 205) $ 82,000.00 Variable costs ($28.70 x 205) ($ 5,883.50) Contribution margin $ 76,116.50 Total fixed cost $ 212,939.00 Fixed cost covered by intracompany sales ($ 76,116.50) Fixed cost remaining $ 136,822.5

To reach break-even the amount of $ 136,822.50 of fixed cost needs to be covered.

Revenue = Variable Costs + Fixed Costs
205($400) + X (800) =(X+205) ($28.7) +$212,939
82,000 + 800X = 28.7X + 5,883.5 + 212,939
771.3X = 136,882.5
X = 177.3921
177.39 commercial hours need to be sold to break-even

Option 1:
Net Loss = ($23,700)
Intracompany revenue hours 223 hours

Commercial revenue hours 97 hours

Intracompany price per hour $400

Commercial price per hour $1,000

Variable cost per unit $28.70
Fixed costs $212,939

Intracompany sales revenue $89,200
Commercial sales revenue $97,000
Total revenue $186,200
Variable Cost ($9,184)
Contribution Margin $177,016
NET INCOME ($35,923)
Income decreases by $12,223.

Option 2:
Revenue hours
Intracompany 223
Commercial 179
Total revenue hours 402
Intracompany price per hour $ 400
Commercial price per hour $ 600
Variable cost per unit $ 28.70
Fixed costs $ 212,939
Sales Revenue
Intracompany (223 * $400) $ 89,200.00
Commercial (179 * $600) $ 107,400.00
Total revenue $ 196,600.00 Variable Cost (402 * $
28.7) ($ 11,537.40)
Contribution Margin $ 185,062.60
Fixed costs ($ 212,939.00) NET INCOME ($ 27,876.40)
Income decreases by $3948.18 (falls from -$23,700 to -$27,876.4)

Option 3:
Revenue hours
Intracompany 223
Commercial 179
Total revenue hours 402
Sales Revenue
Intracompany (223 * $400) $ 89,200
Commercial (179 * $ 800) $ 143,200
Total revenue $ 232,400.00
Variable Cost (402 * $28.7) ($ 11,537.40)
Contribution Margin $ 220,862.60

Total fixed costs $ 212,939
Sales Promotion ($ 8,083)
Total $ 204,856
CM $ 220,862.60 Total fixed costs without promotion ($ 204,856.00) Could be spent on additional promotion $ 16,006.60

At this point, it may seem that Salem Data Services (SDS) is a problem to Salem Telephone Company (STC). It could appear to be so based on the loss that was occurring; however, SDS was able to increase its revenues over the last three months. SDS could become more profitable if the fixed costs were decreased which are $212,939 (that is too much). Maybe it is feasible to convert some of them into variable costs (in order to decrease losses). Also, promotion level could be increased. As we saw in question 5(c), increased promotion can increase hours sold by 30 %. Flores should try to sell the remaining hours each month offering some special offers or some bonuses, for example. Thus, some VC/unit and some of the FC with every unit sold would be covered – Flores would be able to cover a part of the total fixed cost and, as a consequence, get a better result at the end of the next months.