Question

Five Seasons Hotel is a chain with 10 hotels. Strategically, the chain implements a cookie-cutter approach to building and running its hotels, in that all hotels are practically identical. Five Seasons invested $150 million in acquiring the land for all hotels and $500 million in building and furnishing the 10 hotels to a guest-ready stage. Each hotel has 150 rooms. Each room has a rack rate of $200 per night but the hotel gives an average of discount of $30 per night off this base price. Each hotel costs $1 million in materials to run, and is staffed by 58 employees, each paid an average compensation of $50,000 a year. This staffing level implies a certain service level, which together with the rack rate and discount, determines the chain’s average occupancy rate—the percent of available rooms sold—in this approximate way:
Chain-wide average occupancy rate = 0.01 ? number of employees per hotel
? ( 0.0015 ?base Price ) + ( 0.01 ? discount),
subject to a maximum of 100% and minimum of 0% (base Price and discount are expressed in [$]). The company operates 365 nights a year.
1. Draw the ROIC tree and discuss its structure.
2. Use this tree to compute the current ROIC?
3. Reducing the number of employees reduces staffing costs, but it also reduces the occupancy rate when service level drops. What is the ROIC if Five Seasons reduces the number of employees to 50 per hotel?

Answer 1