Prestige Telephone Company
Bradley felt only more time was needed but Rowe felt action was necessary to reduce the drain on company resources. The subsidiary was originally established as a mechanism by which high and nonregulated returns could be used to boost the profits as well as to provide the computer services. Since the Public Service Commission had encouraged public utilities to seek new sources of revenue as a step toward deregulation and to reduce the need for rate increases which higher costs would bring, the PDS had begun selling computer time not needed by the parent company to other businesses.
However, Public Service Commision restricted that the average monthly charge for service by the subsidiary to the parent not exceed $82,000, which was the estimated cost of equivalent services used by the parent company in 1994. By the end of 1996, income of Prestige Telephone Company was low enough giving the lowest return on investment. Rowe felt it was time to reassess Prestige Data Services. Bradley on the other hand asked for more time as she felt the subsidiary would be profitable by the end of the first quarter of 1997.
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But when the quarterly reports came, the three months ended March 1997 all reported a loss. Rowe resolved to study the subsidiary’s operations and assess its performance first before deciding whether PDS be closed down or sold. II. Problem Statement Based on the subsidiary’s current performance and quarterly reports, should Prestige Telephone Company discontinue the operations of its subsidiary? If not, how can Ms. Bradley prove that Prestige Data Services is still profitable despite its losses and can contribute that much to the company, n order to avoid the top management from what other measures should the company take in order to lead the subsidiary into having profits in the near future. III. Methodology First, an analysis of the current reports have been made in order to understand the nature of the subsidiary’s expenses and revenue. Costs were identified and classified for decision-making. Then an incremental cost-benefit analysis was done to weigh whether it would be more beneficial for the company to discontinue the subsidiary’s operations .
Also, various alternative courses of action and scenarios were laid down aside from shutting it down and effects of these courses of actions were also assessed whether it would contribute profits for the subsidiary. Lastly, recommendations were given on how to redesign the reporting system in order to have the most relevant presentation of figures needed in decision-making for the top management. IV. Analysis To discontinue or not? By using incremental cost analysis, it is determined that the company would be better off if they would continue operating its subsidiary rather than to sell or shut it down.
Both alternatives would incur losses however shutting it down would result to larger amounts of losses which includes the costs needed to outsource the data services and the contribution margin forgone from the subsidiary. Based on the first quarter reports of PDS, space, equipment costs (not including power), and salaries and the fixed portion of expenses the subsidiary incur every month. On the other hand, power and operation wages vary according to the use of computers.
The overall cost of running Prestige Data service is quite high as the expenses are more than the revenue thus incurring net losses for the first quarter of 1997. In analyzing the cost-benefit of discontinuing the subsidiary, only the variable costs are relevant and will be considered as well as the opportunity costs. -DISCUSS EXCEL- Also, the non-cancelable leases on computer equipment has still four more years to run. If the company would discontinue the subsidiary, they will still have to pay for the lease without earning revenues from them.
In addition to, the bottomline for the month of March would happen to be a profit if the depreciation is added back, giving a hint that the subsidiary can give inflows to the company and that time may still be needed to prove its profitability. To conclude, there is no need for the company to discontinue the operations of its subsidiary. How can the subsidiary be more profitable? CVP analysis Variable costs include power, operations wages, materials and sales promotions. Needed hours per month to breakeven? Sensitivity analysis a. ncrease price, decrease demand b. decrease price, increase demand c. increase promotions, increase demand d. 2 shifts (16 hours) rather than operating at 24 hours V. Conclusion and Recommendations It is therefore concluded that there is no need for the Prestige Telephone Company to discontinue its subsidiary, the Prestige Data Services, as it is promising to bring the company profits and savings. With just the right changes in relevant factors such as prices and variable costs, the subsidiary can make it to have positive bottomlines.
It is recommended for the management of PDS to prepare a statement of cashflows in order to assess the actual inflow or outflow of cash from the subsidiary. Also, the financial statements can also be presented with the contribution margin the subsidiary brings. It would also be helpful if both the balance sheets of the parent company and subsidiary are shown for better analysis. With the decision to continue the subsidiary, it is also recommended to assess again its profitability after four years or when the computer leases has already expired.