They provide data services, data processing and computer services to commercial companies as well as to Prestige Telephone Company. The data services company was supposed to be profitable by March of 2003. They have been unable to do so. It is up to Mr. Rowe to convince Ms. Bradley to allow Prestige Data Services to stay in business. In order to assist with the preparation of this meeting, we have reviewed several scenarios to decide about the future of the subsidiary.
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Assessment of Strategies The subsidiary has failed to show a positive net income for the first quarter of 2003. It has also failed to keep the monthly computer usage billed to the telephone company under the promised $82,000 per month. Granted, February did show fewer revenues, however, it is a shorter month and therefore fewer billable hours available. In light of the continued net losses, we feel that the subsidiary is a problem to the telephone company and they will continue to be so unless significant changes are made.
If we assume that the telephone service demand will continue to average 205 hours per month, the level of commercial sales of computer use necessary to break even each month will need to increase 27. 5 hours to 170 hours per month. This will increase the computer use revenue to $136,000. Assuming everything stayed the same as in March, this would allow them to break-even but not profit. He outlined four possible scenarios that might possibly make the subsidiary an asset to the company.
The first scenario was increasing the price to commercial customer from $800 to $1000 per hour. The increased cost would reduce demand by 30%; from 132 average hours to 92. 4 hours per month. The monetary effect this would have would drop revenues to $92,400. This creates an elastic demand of 1. 2, which is unadvisable. Ed = . 3 / . 25 = 1. 2 An elastic demand shows that customers are more willing to leave and take their business elsewhere. Next, he looked at reducing the price to commercial customers from $800 per hour to $600 per hour.
This reduction would increase demand by 30%; from 132 average hours per month to 171. 6 hours per month. The increased hours at $800 per month would only bring in $102,960. Even though this creates an inelastic demand (. 05) and increases customers, it is still below the revenue that is currently brought in. Ed = . 3 / -. 25 = . 05 This inelastic demand shows that customers are still willing to stay with the company at this reduced cost and it will attract new customers. Rowe determined that increased promotion would increase sales by up to 30%.
We determined that increased sales of 30% would equal revenue of $137,280. The difference between the current revenue of 105,600 and forecasted revenue is $31,680 which, if added to the net loss in March, would give $10,242 net profit that could be spend on promotion and advertising (assuming all things stayed the same). Reducing operations from 24 hours to 16 hours on weekdays would result in a loss of 20% of commercial revenue hours. The current hours of 512 hours reduced by 20% would drop to about 410 hours.
If we were to assume that a drop of 20% in hours would also mean a drop in variable costs it would still not be enough of a reduction in expenses to cover their net loss. (See Exhibit 1 for calculations). The changes to the accounting and reporting systems that are now used that we think should be made are accounting for the activities of the subsidiary separate from the parent company. We think that a more accurate picture of the revenues would be shown by showing the fees paid to the parent company as opposed to combining the payments to the parent company within the body of the financial statement.
Conclusion After careful consideration of all the data and different scenarios proposed by Mr. Rowe, we have concluded that Prestige Data Services should not remain in business. It is apparent that they are unable to stay within the forecasted budget to charge to Prestige Telephone Company of $82,000. As well, they continue to show a considerable net loss month to month. Each scenario proposed did not show a sustainable formula for ongoing success and profitability.