Question

Kelly Hayes operates a bed and breakfast hotel in a beach resort area of Noosa. Depreciation on the hotel is $60,000 per year. Kelly employs a maintenance person at an annual salary of $30,000 per year and a cleaning person at an annual salary of $24,000 per year. Rates and taxes are $10,000 per year. The rooms rent at an average price of $50 per person per night including breakfast. Other costs are laundry service at $4.00 per person per night and the cost of food which is $6.00 per person per night.

Instructions:

(a)what are total fixed cost and Variable cost per person per night ?


b)Determine the number of rentals and the sales revenue Kelly needs to break even using the contribution margin technique.

(c) If the current level of rentals is 4,000, by what percentage (Margin of Safety) can rentals decrease before Kelly has to worry about having a net loss?

(d) Kelly is considering upgrading the breakfast service to attract more business and increase prices. This will cost an additional $5.00 for food costs per person per night. Kelly feels she can increase the room rate to $65 per person per night. Determine the number of rentals and the sales revenue Kelly needs to break even if the changes are made.

e) Determine the contribution margin per person per night ?

Answer 1

a) Fixed cost is the cost which remain occurs for a given time period and do not change (i.e. remains fixed) and the varuiable is the cost which changes proportionly with change in sales volume but it remains same per unit of output.

Fixed Cost per year = Depreciation+Salary of maintenance person+Salary of Cleaning Person+Rates and Taxes

= $60,000+$30,000+$24,000+$10,000 = $124,000

Variable Cost per person per night = Laundry Service+Cost of foods

= $4.00+$6.00 = $10.00 per person per night

Therefore the total fixed cost is $124,000 and variable cost is $10.00 per person per night.

b) Break Even point is the point at which the profit is zero and fixed cost is equal to contribution margin. The calculation of break even number of rentals and break even sales revenue is shown as follows:-

Contribution Margin per person per night = Room Rent per person per night - Variable cost per person per night

= $50.00 - $10.00 = $40.00

Break Even number of rentals = Total Fixed Cost/Contribution Margin per person per night

= $124,000/$40.00 = 3,100 rentals

Break Even Sales Revenue = Break Even Rentals*Room Rent per person per night

= 3,100 rentals*$50.00 = $155,000

c) Break Even Rentals = 3,100

Current Level of Rentals = 4,000

Margin of Safety = Current Level - Break Even

= 4,000 - 3,100 = 900

Margin of Safety % = Margin of Safety/Current Level of Rentals

= 900/4,000 = 0.225 or 22.5%

d) New Contribution Margin per person per night = Room Rent - Variable cost

= $65.00 - ($10.00+$5.00) = $50.00

Break Even number of rentals = Total Fixed Cost/Contribution Margin per person per night

= $124,000/$50.00 = 2,480 rentals

Break Even Sales Revenue = Break Even Rentals*Room Rent per person per night

= 2,480 rentals*$65.00 = $161,200