Salem Telephone Company Case

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The second option requires a decrease on the commercial sale price from $800 to $600. This decrease will bring up 30% on the commercial hour sold. This total revenue will be

$400*205+ $600 *138* (1+30%) = $189,640

This net income is $3,948 lower than the current one and will also not be considered.

The last option is a promotion to the sale people. The promotion is estimated to boost the demand by 30%. But the manager is not sure how much promotion she can manage to put. We assume the promotion cost for option 3 remains the same and calculate the total revenue as the 30% boost happens.

$400*205+ $800*138*(1+30%) = $224,480

At this time, the net income increases $35,880 and will leave $1,548 for the margin of safety. If the subsidiary wants to give sales promotion higher than $1,548, it will be none profitable again.

We think the subsidiary is a problem for the Salem Telephone company because it is not profitable. Even if the sales are increased by 30% while the sales and costs remaining the same, the net income is still negative. Our suggestion is that the company should first try to break even. As both decrease the sale price and increase promotion boost sales, we recommend the company apply both strategies into practice. Also the company may want to cut some fixed expenses by outsourcing them. Expenses such as the system development and maintenance can be outsourced by other companies and their costs can be lowered.

What else we find out is that this subsidiary uses the contribution approach in generating the income statement. The statement shows it has a highly fixed expense structure which can be proved by calculating the operating leverage for the March $182,555.62/$30,383.39= 6.0084. This number is high and means the profit will be low if the sales are low.

Thus we suggest the company to switch to the traditional approach to generate the income statement. The traditional approach focuses on functions rather than on behavior. In this approach we will allocate the fixed expense into overhead and operating expenses. Also we will get gross margin instead of contribution margin. These differences may give the manager another view of the subsidiary’s cost construction.