Case Study - Salem Telephone Company

Questions

1. "Revenue hours" represent the key activity that drives costs at Salem Data Services. Which expenses in Exhibit 2 are variable with respect to revenue hours? Which expenses are fixed with respect to revenue hours?

2. For each expense that is variable with respect to revenue hours, calculate the cost per revenue hour.

3. Create a contribution margin income statement for Salem Data Services. Assume that intra company usage is 205 hours. Assume commercial usage is at the March level.

4. Assuming the intracompany demand for service will average 205 hours per month, what level of commercial revenue hours of computer use would be necessary to break even each month?

Since the intracompany demand is known to be 205 hours, the contribution from these sales is assured to cover a portion of the fixed costs. Thus, to determine the level of commercial revenue hours required to break even, the contribution from commercial sales only needs to cover the fixed costs remaining after subtracting the fixed costs already covered by the contribution from intracompany sales.

5. Estimate the effect on income of each of the options Flores has suggested if Wu estimates as follows:

Increasing the price to commercial customers to $1,000 per hour would reduce demand by 30%.

Reducing the price to commercial customers to $600 per hour would increase demand by 30%.

Increased promotion would increase revenue hours by up to 30%. Wu is unsure how much promotion this would take. (How much could be spent and still leave Salem Data Services with no reported loss each month if commercial hours were increased 30%?)

6. Based on your analysis above, is Salem Data Services really a problem to Salem Telephone Company? What should Flores do about Salem Data Services?