Prestige Data Services

Exhibit 1

Revenue Hours Jan Feb Mar

Intercompany 206 181 223
Commercial 123 135 138
Total 329 316 361
Service Hours 32 32 40
Available 175 188 167
536 536 568

Exhibit 2 Is this Cost:

Jan Feb Mar Fixed/Vbl
Revenues
Intercompany 82,400 72,400 89,200 V
Commercial
Computer Use 98,400 108,000 110,400 V
Other 9,241 9,184 12,685 ??
Total 190,041 189,584 212,285

Expenses
Space 8,000 8,000 8,000 F
Custodial Services 1,240 1,240 1,240 F
9,240 9,240 9,240

Equipment Costs
Computer Leases 95,000 95,000 95,000 F
Maintenance 5,400 5,400 5,400 F
Depreciation:
Computer Equipment 25,500 25,500 25,500 F
Office Equipment and fixtures 680 680 680 F
Power 1,633 1,592 1,803 F=180+V=4/hr (see Cost_Behavior sheet)
128,213 128,172 128,383

Wages and Salaries

Operations 29,496 29,184 30,264 F=21600+V=24 (see Cost_Behavior)
Systems development and maintenance 12,000 12,000 12,000 F
Administration 9,000 9,000 9,000 F
Sales 11,200 11,200 11,200 F
61,696 61,384 62,464

Materials 9,031 8,731 10,317 all F (see Cost_Behavior)

Sales promotions 7,909 7,039 8,083 all F (see Cost_Behavior)
Corporate services 15,424 15,359 15,236 all F (see Cost_Behavior)
Total expenses 231,513 229,925 233,723
Net Income (loss) (41,472) (40,341) (21,438)

1. Look at Exhibits 1 & 2 above. How are the financial results looking over time? Is there a trend?
2. To find the break-even point, we need to know a) fixed costs and b) contribution margin per hour
a First identify which costs are fixed, which variable.
b Add all fixed costs.
c Next, find how much the contribution from intracompany sales will be.
d The difference between b and c is the mount of fixed cost not recovered from intracompany sales.
e Now find out how many hours of outside sales are needed to break even.
3. With the fixed and variable classification, you can use a spreadsheet to explore the 4 alternative scenarios listed in the case.
In particular, option d will require you to make stronger assumptions than the others.
4. Does the work you have done suggest any changes that might be useful to Rowe and Bradley?
Computing Fixed and Variable Costs
Fixed Costs Variable Costs Do-nothing Volume
Most costs are fixed: March Power 4 Intra-co 205
Space F 8,000 Wages 24 Commercia 140
Custodial Services F 1,240 Total 28
Equipment Costs
Computer Leases F 95,000 Contribution Margin Total
Maintenance F 5,400 SP VC CM "Do-nothing" CM
Depreciation: Intra-Co 400 28 372 76260
Computer Equipment F 25,500 Other 12,685
Office Equipment and fixtures F 680 Commercia 800 28 772 108080
Power F 180 BEV with 205 hrs Intra-Co sales
Wages and Salaries Total FC 223,436
Operations F 21,600 CM from Intra Co Sales & Other 88,945
Systems development and maintenance F 12,000 Unrecovered FC 134,491
Administration F 9,000 CM per hour of commercial work 772
Sales F 11,200 # commercial hours to BEP 174.2111
Materials F 10,317
Sales promotions F 8,083 Conclusion:
Corporate services F 15,236 So as long as commercial hours are about 175 hours a month
Total Fixed 223,436 PDS will break even. This becomes the basis for further work.
Total Expenses 233,723

Next we look at alternatives

a. Increase commercial price
New Revenue 1000
VC 28
New CM for commercial sales 972
New volume 98
Total expected commercial CM 95,256
More or less than do-nothing CM Less
b. Drop commercial price
New Revenue 600
VC 28
New CM for commercial sales 572
New volume 182
Total expected commercial CM 104,104
More or less than do-nothing CM Less
c How much is Sales Promotion worth?
Revenue with sales promotion 800
VC 28
CM 772
New volume 182
Total expected commercial CM 140,504
Total Intra-co CM+Other 88,945
Total CM 229,449
Total FC 223,436
Available for additional Sales promotion 6,013
1. Analysis of Power Costs: Identifying FC & VC
Method 1: Simple Rise-run analysis
Hours 361 348 401
Power Cost 1,633 1,592 1,803
Change in
Hours -13 53
Power Cost (41) 211
Slope 3.1538461538 3.981132
Fixed 494.461538462 206.566

Method 2: Using Regression

Billable Hours + Service Hours Billable Hours alone
Power Power
Hours Cost Hours Cost
361 1,633 329 1,633
348 1,592 316 1,592
401 1,803 361 1,803

SUMMARY OUTPUT SUMMARY OUTPUT

Regression Statistics Regression Statistics

Multiple R 0.998581525 Multiple R 0.99498239
R Square 0.997165061 R Square 0.98998995
Adjusted R Square 0.994330123 Adjusted R Square 0.97997989
Standard Error 8.424360856 Standard Error 15.8300876
Observations 3 Observations 3

ANOVA ANOVA
df SS MS F df SS MS F
Regression 1 24963.0301442 24963.03 351.7413 Regression 1 24783.40832815 24783.41 98.89957
Residual 1 70.9698558322 70.96986 Residual 1 250.5916718459 250.5917
Total 2 25034 Total 2 25034

Coefficients Standard Error t Stat P-value Coefficients Standard Error t Stat P-value
Intercept 179.5124509 79.940481068 2.245576 0.266715 Intercept 64.149161 162.3368161885 0.395161 0.760422
X Variable 1 4.044560944 0.2156550809 18.75477 0.033912 X Variable 1 4.80671224 0.4833379817 9.944826 0.063801

I like the first regression better: F is higher.

2. Analysis of Operating Wages

Rise-run analysis
Hours 329 316 361
Wages 29,496 29,184 30,264
Slope 24 24
Fixed 21600 21600

3. Analysis of Other Costs

Using Regression
Hours Materials Sales promotio Corporate services
361 9031 7909 15424
348 8731 7039 15359
401 10317 8083 15236
(I) Regressing Materials on Hours (ii) Materials on Hours: Rise-run
SUMMARY OUTPUT Rise-Run Slope estimate
Jan-Feb Feb-Mar
Regression Statistics 23.0769230769 29.9245283
Multiple R 0.998286136 Fixed estimate
R Square 0.996575209 Jan-Feb Feb-Mar
Adjusted R Square 0.993150417 700.2307692308 -1682.73585
Standard Error 69.73006056 FC < 0 is nonsensical!!!
Observations 3

ANOVA
df SS MS F Significance F
Regression 1 1414868.38532 1414868 290.9886 0.0372773808
Residual 1 4862.28134557 4862.281
Total 2 1419730.66667

Coefficients Standard Error t Stat P-value

Intercept -1906.66361 661.682788911 -2.881537 0.212652
Hours 30.44954128 1.7850187222 17.05839 0.037277

The intercept which would normally be interpreted as the fixed cost is negative!
This means we cannot develop a simple linear model between hours and material cost.

How about the other two: Sales promotion and Corporate Services?

Sales promotion is discretionary cost -- so I didn't even try to link it to hours

Corporate Services: we could try, I didn't.

In effect, after looking at the numbers it is obvious that the variation is small and so the costs are
most likely quite reasonable to treat as fixed/discretionary. That's what I chose to do.