Questions From The Reading

1. Appraise the results of operations of Prestige Data Services. Is the subsidiary really a problem to Prestige Telephone Company? Consider carefully the differences between reported costs and costs relevant for decisions that Daniel Rowe is considering.

When all the facts given are taken into account, one will note that the statements are only for a short-term outlook only. If a projection is to take place on the numbers, it is clear to see that the loss is shrinking Jan ($41,472), Feb ($40,341), and Mar ($21,438) and will eventually turn into gains with possible substantial gains for the company. The main point that shall be considered will be that the reader is only given a very short-term look at the financials (January – March). This will indicate that the marketing or word of mouth must have been working due to the percent usage that went up every month. Opening costs for that division are not included. Therefore, there is a need to project when you can get it paid off to leave the company with complete profit. As stated above, there is currently a loss shown but the loss keeps lowering itself. Therefore, if the trend keeps moving in this direction, the division is bound to start to make money. There is no guarantee of this but trends do help project for a division or company. If the company is to try to use an outside source to provide data service, it will cost $164,000. However, why shall this be done when Prestige Phone is paying $82,000 to Prestige Data. When the math is done, this is showing that by using Prestige Data they are saving approximately $82,000 by holding a

24 hours equates to $149. what level of commercial sales of computer use would be necessary to break even each month? In order to determine the break even each month for the company it is important to make a few distinct assumptions.02 is determined by taking the average variable cost per month divided by the average total hours per month. $10. Secondly. .02 and is the same for both commercial and intercompany hours. and March. it will be assumed the variable cost per unit is $189.000 cost limit to Prestige Telephone Company. First it will be assumed the company demand for service will average 205 hours per month. If I am correct.792 in sales. With these assumptions it has been determined that Prestige Data Services needs to have 187. February. Therefore. It will also be assumed the “Other Income” will be held constant at $10. Assuming the company demand for service will average 205 hours per month. $189. 2.separate division. 187.370 is derived from taking the average monthly “Other Income” for the months of January.370. both also provide money to each other’s division that will help their individual income statements. it will be assumed that Prestige Data Services can produce a sale that does not equal a full hour. This will lead to the $82. How can this be considered a problem? They need to keep Prestige Data Services since it may become a cash cow for the company in the future.24 hours of commercial sales in order to break even. Finally.

.3. Please See The Excel Sheets on the next page for the answers to question 3.

there are some costs that will still exist even if there is no such subsidiary. the lease. Given you drop the subsidiary. compare the additional revenues from adding the segment to the additional costs that will be incurred. So. I suggest the absolute profitability to Prestige Company. More specifically. we can easily tell that the total revenue is in the trend of increasing and the decreasing of loss of net income. Can you suggest changes in the accounting and reporting system now used for operations of Prestige Data Services which would result in more useful information for Rowe and Bradley? It seems like the company is losing money from the results in the accounting and reporting system. A lot of managers are adopting this method to help them make the crucial decisions whether or not to drop the segments or the subsidiary. as mentioned above. from the first question we have already shown that the subsidiary is actually not a problem because of the break-even. Only . which means that the company can cover all the cost including the fixed cost and the variable cost. the managers are in the charge of these payment. Second. First. in the first Quarter 2003.4. It is absolutely a good sign that the subsidiary is doing a better job month after month. Third. Here are some aspects that you cannot ignore when you analyze if it's profitable or not. and it can work as a virtuous circle. when considering a new potential segment. This method measures the impact on the organization's overall profits of adding or dropping a particular segment such as a product or customer without making any other changes. computer equipment and so on. as shown in the 2nd chart. maintenance.

is all that is allowed to be charged and that is set by the Public Service Commission. Currently.the additional costs that shall actually be avoided or incurred will be included. Questions From Instructor 1. If those 177 hours are commercial sales. Due to the restrictions put in place. All other costs are irrelevant and shall be ignored. but only receiving half the income from it. the $400 per hour does not show the true value that Prestige Data Services provides Prestige Telephone Company.) Why is Prestige continuing to report operating losses? Prestige Data Services continues to show operating losses because the charge to Prestige Telephone does not fully show the value the company is providing them and because they are not generating enough outside sales. this accounts for the majority of their sales as well. Combined these has created a negative net income on the financial statements. On average there are approximately 177 hours that are still available. $82. the next issue to address shall be the amount of available hours that are not producing any revenue while still having costs associated to them. If they are charging closer to the market rate.000. Prestige Telephone Company. . there is a limit placed as to what Prestige Data Services can charge the parent company. Unfortunately. Prestige Data Services is providing the same service at the same cost of doing business. for hours of service. Based on the averages. instead of wasted hours. Since there is a limit as to what Prestige Data Services can charge the parent company. On average. they will be showing an operating gain. this equals $400 per hour of intercompany service which is half of what is charged for commercial sales.

However. 24-hour operations mean higher salary for employees because of the intense work load. That they do not operate well is not the only cause. First. Unless an improvement on how many of those hours are sold or perhaps the amount of hours the company is operating is decreased. as mentioned in the last sentence of the case.333 of revenue. expenses decrease. nevertheless. as being informed by Mr. Rowe definitely shall consider going to two-shift workplace instead of 24-hour operation. and responsibility can be more clearly defined for both technical staff and other employees. Rowe needs to choose between all jobs done by outside contractors and all done by inside technical support. what would you recommend to Mr. Mr. Rowe. From the data revealed in the two exhibits. Also. there are several changes for Prestige to consider. Mr. the company will continue to show operating losses. In this way. 2.then they can produce $141. and will lower their efficiency and effectiveness. Twenty-four hour operations are exhausting for all employees. testing and upkeep. some book-keeping inappropriateness shall also be taken into considerations. Based on your appraisal of the results of operations of Prestige Data Services in the first quarter of 2003. Prestige Data Services suffers financial losses because of many reasons. Rowe? In our opinion. They count for the “system development and maintenance” wages and salaries. the money seems to be spent on different people for the same reasons. Second. In this scenario. By changing this . money can be saved. maintenance is carried out by outside contractors every week for eight hours. there are also maintenance activities inside the company by their programming staff.

Their basic salaries can be lowered due to lighter work load. Rowe will find out the true reason for all those 500 plus available hours and make these hours into profit-generating time. are too high every month. since rent and custodial services. Bradley so that they might more easily understand how well Prestige Data Services is performing? . the Telephone Company will earn extra revenues. employees work fewer hours. Last but not the least. They will lose the bargaining leverage for higher wages. Rowe and Ms. Another possible problem is that operations staff is not fully performing their responsibilities. Third. collections. Either scenario. What specific suggestions for improving the accounting system and report format would you suggest to Mr. This condition may reveal two problems. 3. along with all the payroll. or some other excuses. while the subsidiary suffers some losses. As they are not able to retain current customers and obtain new ones.situation into two-shifts. They may not have enough communication with customers. which do not generate revenue. Mr. and accounting costs are provided to Prestige Telephone Company. billing. They count as one third of total hours. operation employees are delayed from performing their duties. Rowe needs to start thinking of the subsidiary as part of his company. Mr. Because of money collected from Prestige Data Services. every time they go to work. available hours.

the use of incremental cash flow can. if the initial investment of the project. generally speaking. we have means to more accurately predict the performance of a business that is. For example. and this will immediately make a difference of $36. can create value for the company as a whole. is to calculate the difference between running and not running Prestige Data Services. we will know how to do the overall calculation.The suggestion for improving the accounting system and report format that we will like to suggest to the managers will be a system that focuses on incremental cash flow. For example.180 depreciation for January is no longer an expense. is $10. the difference of cash flows that it will generate if Prestige Data Services is run or not. assuming a tax rate of 40%. Finally. though seeming not well run. As for implementation of incremental cash flow. which represents the expected rate of return of the company.652 comparing to the current accounting and reporting system.000. it will be inaccurate to use a short-term statistics to predict its performance in a long run. it helps the company to reduce. Managers shall appreciate this method. calculating its net present value (NPV). and the company generates a $10. because Prestige Date Services. or the cash outflow. the equipment is rent for 4 years and is not cancellable. rather. which is. Calculating the incremental cash flow. Moreover. Because such an investment is usually viewed in the long run. if we count on incremental cash flow. First we have to figure out a discount rate. $10.500 cash inflow at . Assuming the president of Prestige Company. because it provides more accurate information for them to evaluate business value. in fact. as in this case. but the contribution is simply neglected if we use stats of Prestige Data Services separately. $26. he will use this method to value the business. therefore we assume that it will last at least 4 years. change the situation that the subsidiary is not well operated even without looking into the value it creates for the whole business. caring the value created for the whole company.472 tax payable.

unfortunately.545. we can see that it only generates $10. which means if the project requires only one initial investment of $10. the company earns $500.21. and the result will be 10.100. a negative NPV. it will be divided by 1. because the investors will like the return to represent the value created for two years.000+$9.21. and in this case. the NPV will be -$10. Combining these numbers together. and discount the year one cash flow. for most investors.the end of the year. assuming an inflation of 2%. 4. If we use a discount rate to discount the cash inflow of year one. is the company doing well? Literally. the denominator will be 1. which indicates the project is not creating value. and (1+10%)*(1+10%)=1.500/ (1+10%) =$9.100 at the end of year two. thus we will reject it. Would you recommend that Ms. so.545. when calculating the NPV.545+$10. If we assume the investors will like to earn 10%.000=$9. then figure out a reasonable discount rate to represent their required rate of return.500 at the end of year one and $12. the company generates profit. if the cash inflow of year two is 12. investors will be happy to invest if their rate of return is 10%. and can generate profit of $10.000. The fact is. a 3% return is not good enough. Notice that for the second year. we can calculate the NPV of the project as -$10. and finally calculate the projects NPV to decide if the project is acceptable or not.000+$9. Rowe adopt any of the options which are discussed in the case and reviewed in the questions shown at the end of the case description? . Bradley and Mr.545=-$455. it can be totally different. All in all.000. what we suggest the managers to do is first calculate the incremental cash flows of the subsidiary.21.

as long as they structure based upon the recommendations of this option. the only option that will be recommended for them to review will be the option to increase sales efforts and promotions. This will make the company very valuable and an asset to Prestige Telephone Company. The more sales they obtain. Let us hope they choose wisely and ensure that both ends of the company thrive for many more years to come. the better off the company will be financially. Therefore. Therefore. as one could see. the best and only option will be to increase sales. As shown in the Excel Spreadsheets regarding question number three and the above listed options it is very clear to see that all but one of the options will cost the company significant losses. . increasing sales efforts and promotions. they will suffer loss and may have to close Prestige Data Services. The reason being this option will show a breakeven or profit depending upon how the option is handled and launched by the company. and of going to two-shift rather than 24-hour operations (Prestige Telephone Company Case 9-197-097). If any other options are used. reducing prices. If they try to reduce costs by any means this will not help since they cannot cut there or anywhere else.The options in the case are as follows: estimate the possible effects on profits of increasing the price to customers other than Prestige Telephone. A large chunk of their money goes to fixed costs that cannot be altered.

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