The fixed costs, with respect to revenue hours, are rent and custodial services for the space that is leased by Salem Data Services as well as the computer leases, maintenance, depreciation of the computer equipment and the depreciation of the office equipment and fixtures. Other fixed costs include the salaried staff in charge of operations, the salaried staff that are in charge of the systems development and maintenance, the administration staff and the sales staff, which are also salaried. These are all fixed costs because they stay the same each month and are not affected by the change in revenue hours each month.
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The last two fixed costs are sales promotion and corporate services. Sales promotion is considered a fixed cost because the expense is not related to the current level of work. This cost was determined by the managers’ estimation of how much they needed to spend in order to acquire new clients. Corporate services are also considered a fixed cost because they not related to the level of work or monthly revenue hours that are generated. Exhibit 1A on the attached worksheet shows the variable and fixed cost breakdown for each month. 2. ) Cost Per Revenue Hour
For the power variable cost, the cost per revenue hour is found by taking the power expense for each month and dividing it by the total revenue hours for each month. For January, the power expense is $1,546 and the total revenue hours are 329. The cost per revenue hour is $4. 70 ($1,546/329). For February, the power expense is $1,485 and the total revenue hours are 316. The cost per revenue is $4. 70 as well ($1,485/316). For March, the power expense is $1,697 and the total revenue hours are 361. Cost per revenue is again $4. 70 ($1,697/361).
For the hourly personnel, the steps taken above are used to compute the cost per revenue. For January, the hourly personnel wages are $7,896 and the total revenue hours are 329. The cost per revenue hour is $24 ($7,896/329). In February, the hourly personnel wages are $7,584 and total revenue hours are 316. The cost per revenue hour is again $24 ($7,584/316). Finally in March, the hourly personnel wages are $8,664 and the total revenue hours are 361. The cost per revenue hour comes out to be $24 ($8,664/361). The total cost per revenue hour for each is $28. 0 and this is computed by adding the cost per revenue hour for the power expense and the hourly personnel together. These calculations can be found in Exhibit 2A on the attached worksheet. 3. ) Contribution Margin Income Statement Exhibit 3A on the attached worksheet shows the contribution margin income statement for Salem Data Services when Salem Telephone usage is 205 hours and the commercial usage is at the March level of 138 hours. The total sales are $192,400 of which $82,000 belongs to sales made from Salem Telephone at a $400 sales price and $110,400 of this belongs to commercial usage at a sales price of $800.
The total variable costs are $9,844. 10. This was found by taking the total cost per revenue hour of $28. 70 and multiplying it by the total revenue hours, which were 343 (205+138). The contribution margin is $182,555. 90. This was determined by taking the total sales of $192,400 and subtracting out the variable costs of $9,844. 10. To get the net income, the total fixed costs of $212,939 are subtracted from the contribution margin, which produces a loss of ($30,383. 10). 4. ) Breakeven Point In order for Salem Data Services to breakeven each month, they will need to produce roughly 178 hours.
Exhibit 4A on the attached worksheet shows the equation and calculation for the breakeven point. The equation for breakeven point is total sales equals total cost (variable and fixed). The total sales for Salem Data Services was the intracompany sales of $82,000 (205 hours X $800) plus the commercial sales of $800(X). The (X) represents the amount of unknown commercial hours that we are trying to find. The total costs are the cost per revenue hour of $28. 70 multiplied by both the 205 intracompany hours and the unknown commercial hours (X) plus the fixed costs of $212,939.
The breakeven point is 40 more hours than Salem Data Services sold in March. Overall, from January to March, the amount of commercial hours sold has increased, but in small increments. Salem Data could reach this breakeven point in a future month if their hours continue to increase, but they will be susceptible to an increase in their variable costs and an increase in a couple of their fixed costs, such as sales promotion and corporate services. 5. ) Income Effect Estimation In option 1, Flores has suggested that Wu increase the price to commercial customers from $800 to $1,000.
He projects that this will decrease demand by 30%. If this were to occur, the net income would be a loss of ($42,995). Exhibit 5A on the attached worksheet illustrates how this number was determined. Total sales were $178,600, variable costs were $8,656, and fixed costs were $212,939. When the variable fixed costs were subtracted from the total sales, this produced the loss mentioned above. Option 1 would not be a viable option for Salem Data Services because it still produces a negative net income.
In option 2, Flores suggested that Wu decrease the price to $600 for commercial customers. Making this change is projected to increase demand by 30%. In this projection, net income will still be a loss of ($34,331). Exhibit 5B illustrates how this number was determined. Total Sales were $189,640, variable costs were $11,032, and fixed costs were $212,939. After the variable and fixed costs were subtracted from the total sales, the effect was a loss. Option 2 would also not be a viable option for Salem Data Services because again it still produces a negative net income.
In option 3, Flores has suggested to Wu that increased promotion would increase revenue by 30%, but Wu is not sure how much promotion would be needed. To find how much promotion would be needed, we calculated the effect of the 30% increase. The price in this option remained at $800 for commercial customers. Exhibit 5C illustrates this. The total sales were $225,520, variable costs remained the same as in option 2 of $11,032, and fixed costs were still $212,939. When the variable and fixed costs were subtracted from the total sales, this produced a positive net income of $1,549.
Wu should increase the sales promotion expense by this amount to generate positive income. This, however, is contingent upon the demand increasing by 30%. 6. ) Based on my analysis, Salem Data Services is a problem to Salem Telephone Company right now because even with a price increase or a demand increase, the company will still produce a loss. If Flores were to close down Salem Data Services, he would save Salem Telephone Company the following costs: Rent| $8,000| Maintenance| $5,400| Power| $1,697| Operations: Salaried Staff| $21,600| Operations: Hourly Personnel| $8,664|
Systems Development and Maintenance| $12,000| Administration| $9,000| Sales| $11,200| Sales Promotion| $8,083| Total| $85,644| The custodial services and the expenses for the equipment and depreciation are not included in this list because the custodial services were based on an estimated annual cost per square foot and will still have to be paid for the remaining months of the year. The leases for are noncancelable and will still have to be paid until the lease period is up. The depreciation will also still occur while Salem Telephone has the equipment in their possession.
Moreover, I did not include the corporate services in this list because I assume that Salem Telephone will still have to collect some accounts receivable and will still try to collect on past-due accounts, even after Salem Data Services is closed. Furthermore, if Flores decides to shut down Salem Data Services, he will have to outsource his computer services to another company and pay the market price of $800 instead of $400, which is currently being paid to Salem Data Services. If Salem Telephone were to use the 205 hours as estimated previously, then the company would have to pay $164,000 (205 hours X $800) monthly to another ompany. This means that Salem Telephone would end up paying $78,356 ($164,000-$85,644) more to another company rather than keeping Salem Data Services in business. My recommendation to Flores would be to keep Salem Data Services open. I believe as Wu does that given time, the company will start to generate a profit. In the meantime, Flores should have Wu keep the price of commercial usage at $800, but try to increase demand by 30% to at least breakeven each month. Once this occurs, then Wu should increase sales promotion to try to obtain more customers and increase commercial usage.