Question

John Bilodeau is the managing partner of a business that has just finished building a​ 60-room motel. Bilodeau anticipates that he will rent these rooms for 12,000 nights next year​ (or 12,000

​room-nights). All rooms are similar and will rent for the same price. Bilodeau estimates the following operating costs for next​ year:

The capital invested in the motel is $1,040,000. The​ partnership's target return on investment is 30​%.

Bilodeau expects demand for rooms to be uniform throughout the year. He plans to price the rooms at full cost plus a markup on full cost to earn the target return on investment.

Requirements

1.	What price should Bilodeau charge for a​ room-night? What is the markup as a percentage of the full cost of a​ room-night?
2.	Bilodeau​'s market research indicates that if the price of a​ room-night determined in requirement 1 is reduced by 55​%, the expected number of​ room-nights Bilodeau could rent would increase by 55​%. Should Bilodeau reduce prices by 55​%? Show your calculations.
Variable operating costs			$ 3 per room night
Fixed costs
Salaries and wages			$170,000
Maintenance of building and pool			52,000
Other operating and administration costs			222,000
Total fixed costs			$444,000

$444,000

Answer 1

1.

On a full cost mark-up basis, the profits are based on the stated percentage of mark-up added to the total cost incurred (Fixed and Variable). Here’s what Bilodeau should charge for a room-night:

Break-up of price per room night
Variable Cost:
$3 x 12000		36000
Total Variable cost		36000
Fixed Cost:
Salaries & Wages		170000
Maintenance of building and pool		52000
Other operating & Administrative costs		222000
Total Fixed Cost		444000
Total Cost		480000
Add: Mark-up
(30% on $1040000)		312000
Total Price		792000
Available room-nights		12000
Price per room-night		66

2.

What if price dropped by 55% and Room-nights shot up by 55%
Price per room-night (Existing)		66
Less: Reduced		36.3
Price per room-night (New)		29.7
Number of room-nights (Existing)		12000
Add: Increase		6600
Number of room-nights (New)		18600
Total Earnings (18600 x $29.70)		552420
Less: Variable Cost
(18600 x $3)		55800
Contribution		496620
Total Fixed Cost		444000
Profit		52620
Drop in Profit ($312000-$52620)/$312000 x 100		83%

Therefore, Bilodeau should never drop his price per room-night as this will amount to 83% reduction in profits which is far way down below his targeted return on investment.