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BIZ201 Accounting for Decision Making: Case Study Part B Assessment Answer


ASSESSMENT BRIEF
Subject Code and TitleBIZ201 Accounting for Decision Making
AssessmentCase Study Part B
Individual/GroupGroup (2-3 students)
Length2,000 words
Learning Outcomes
  1. Explain and evaluate the role and importance of financial information in business decision making
  2. Apply relevant accounting concepts to simple business scenarios
  3. Apply basic costing and budgeting techniques to business decision making
  4. Apply capital budgeting techniques to capital investment scenarios

Context:

This assessment is aimed at consolidating knowledge from Modules 1-6. By prescribing this assessment, you are able to reflect on your understanding of the importance financial information in business decision making and be able to apply costing and capital budgeting techniques to business scenarios like given in this case study.

Instructions:

  1. Submit two files; Excel Workbook and the Business Report. This Excel Workbook is available on Blackboard under assessment section. Download it, perform calculations on it and submit it.
  2. Include a reference list to any textbooks, websites or other resources used to prepare the answers including references to suppliers that the costing was based on.
  3. For every task, show all workings through appropriate Excel formulas. Copy pasted numbers without appropriate Excel formulas will not be accepted.
  4. Unless otherwise instructed, round your numerical answers to two decimal places.
  5. Submit your assessment files using the following naming convention:

Crystal Hotel Pty Ltd introduced in Part A of the Case Study has a quite flat organisational structure as per the chart below. The General Manager oversees each departmental manager directly.

You have been offered an internship opportunity as a group to show your skills and how you could be of benefit to the organisation. At the end of the internship, there may be an employment opportunity for the members of the group.

You need to choose as a group whether you would like to take on your internship in the Sales and Marketing Department or Functions and Events Department.

Based on your choice, complete the section of the assessment related to the department you have selected.

As per information provided in part A of the case study, the owners of the Crystal Hotel are planning to renovate and refurbish the hotel. A part of the redevelopment plan is to build a Wellness Centre on the rooftop of the hotel. The Sales and Marketing Manager volunteered to help with this project. He is a strong believer that it would bring the hotel up to the next level and that it would attract additional customers to the hotel.

Due to the location of the hotel being within proximity to the business district of Parramatta, he believes that the Wellness Centre should be opened to external clients as well. He suggests employing a full time, in-house trainer and a part-time dietician. He believes selling monthly membership including training sessions and dietary advice will attract additional clients who may then promote the hotel to their employers for accommodation and other business-related services.

The marketing manager wants to be well prepared to support the Wellness Centre project and needs help with few tasks from your team.

TASK 1

As part of the Wellness Centre Project, the plan is to build a small gym on the rooftop of the hotel. You have been appointed to help the Sales and Marketing manager to make decision whether to rent or buy specific equipment items. The required items are included in Appendix 1 together with costing information. The budget for the required equipment is $51,000 for the life of the equipment.

Regarding the buying of the equipment, the useful life is predicted to be 3 years after which replacement is needed. At the end of its useful life, it is expected to be sold for the residual value of 20% of its original cost. A servicing contract will be drawn up with a company to take care of the equipment. Servicing will add 3% to the cost each equipment. This is to be paid separately as one lump sum at the beginning of the term and will last 3 years.

For the renting option, choose the one that is the most beneficial for the business. The rent is expected to rise by 10% each year. The rent is paid at the beginning of each period.

Servicing of the equipment is included in the rent.

REQUIRED

The manager would like to know whether it would be better for the Hotel to buy the required equipment or to rent it. Explore both options and make a recommendation. Take into account the time value of money at the discount rate of 7%. Include advantages and disadvantages of each option and justify your choice.

TASK 2

The Sales and Marketing Manager has an idea of creating monthly memberships for external visitors that he would like to explore further. He is thinking to create two types of membership options. A Basic Membership which would include access to the gym, sauna and pool and it would cost clients $40 a week. A Full Package Membership would additionally to the access include a one-hour weekly session with the in-house personal trainer and a dietician consultation once a month. Clients would pay $81 per week for this type of membership.

He believes that an initial investment into promoting the centre would be $53,373 and subsequent cost of continuous promotion would be $808 per month.

Based on his calculations he believes offering the membership to the external clients would generate total revenue of $151,000 in the first year increasing by 10% every year after that. The in-house trainer is expected to cost the hotel $6000 per month and the services of dietician additional $1700 per month and both are expected to increase by 4% each year.

REQUIRED

Calculate the net present value of the external membership project over the next 3 years period. Use yearly basis for your calculations. The estimated cost of capital for the hotel is 7%. Assume 30% company tax in Australia when determining the values of the after-tax net cash flow for each year.

Based on your analysis would you recommend accepting the project and offer the membership to the external clients? Explain the basis for your recommendation.

TASK 3

Once the Crystal Hotel Wellness Centre is ready for opening, it will need to be promoted to existing and potential new clients. There is already an opening event (luncheon) planned which is handled by the Functions and Events Department. The overall budget for promoting the opening of the centre is $35,000. The opening luncheon is budgeted to cost $23,000.

Your team has been appointed to plan additional promotional activities for the remaining

$12,000. The budget is aimed for the promotion of the opening of the centre only. Continuous promotional activities as well as online advertising will be handled separately.

The marketing team has done initial research and the promotional activities to be considered are listed in the Appendix 3. Negotiated pricing has been included as well.

REQUIRED

Choose suitable promotional activities from the list provided to you and create a promotional budget for the Crystal Hotel Wellness Centre opening. Justify your choice of activities.

TASK 4

The GM has suggested Crystal Hotel to run a promotion to boost the occupancy rates of the hotel. They aim to charge $120 per person for one night’s accommodation including buffet breakfast. The variable cost per person is $35 that includes food, cleaning and utilities. Fixed costs are $40,000 per year that include council rates rate, water rates and land taxes. There are 100 rooms in the hotel and the hotel operates all year round. In general, without any promotions, the normal occupancy rates are 70% throughout the year.

REQUIRED

They have asked for your expertise to carry out a CVP analysis for this promotion. Calculate the following:

  1. The contribution margin per service (a unit of service is one night’s accommodation for one guest).
  2. The contribution margin ratio.
  3. The annual break-even point in number of services and in dollars of service revenue.
  4. The number of services required to earn a target net profit of $150,000 for the year (ignore income taxes).
  5. Analysis the importance of CVP analysis and comment on effectiveness of this promotion based on your calculations.
  6. Some of the marketing team suggest that the room charge for the promotion should be raised to $150. Comment on whether this should be done and what effect it will have on reaching the target profit.

Answer

Contribution Margin refers to the sales price minus variable cost and can be calculated on per unit basis (sales price per unit minus variable cost per unit). Alternatively, it can also be calculated on total basis by subtracting total variable cost from revenue. It can be seen as contribution towards recovering fixed costs.

In the given case, contribution margin can be calculated as:

Revenue per Unit = $120

Variable Cost per Unit = $35

Contribution Margin = $120-$35 = $85 per unit (or per service).

Contribution Margin Ratio can be calculated as Contribution Margin divided by Total Sales. Alternatively, it can also be calculated as Contribution Margin per unit divided by Revenue per unit. 

In the given case, contribution margin ratio can be calculated as:

Contribution Margin = $85 per unit (or per service).

Revenue per Unit = $120 per unit (or per service)

Contribution Margin Ratio = $85/$120 = 71%.

Annual Breakeven Point can be calculated as fixed costs divided by contribution margin. It is the level of sales (in terms of units or amount) at which profit is equal to zero. In other words, this level of sales volume achieves recovering both variable costs and fixed costs.

In the given case, annual breakeven point in terms of units can be calculated as:

Fixed Costs = $40,000

Contribution Margin = $85 per unit (or per service)

Breakeven Point (units) = $40,000/$85 = 471 units

Annual breakeven point in terms of sales amount can be calculated as:

Breakeven Point (amount) = Breakeven (units)*Revenue/Unit = 471*$120 = $56,471.

In such a case, the required number of services to earn a target profit of $150,000 can be calculated, by adding required profit to fixed cost and then calculating breakeven point as follows:

Fixed Costs = $40,000

Contribution Margin = $85 per unit (or per service)

Target Profit = 150,000

Required Units = (Fixed Cost + Target Profit)/Contribution Margin

Required Units = (40,000+150,000)/85 = 2,235 units (or services). 

Assuming that the 100-room hotel is operational at 70% occupancy for 365 days in a year, this level of 2,235 units (or target profit of $150,000) can be achieved in 32 days. 

The Cost-Volume-Profit Analysis (CVP Analysis) helps managers to analyse relationship among sales price, production and sales volume with respect to various kind of costs. It assists in areas such as production planning, profit planning, and expansion plans etc. For example, a manager can decide the sales price point of a product basis the CVP analysis with requisite level of profit. An important aspect of the analysis is called breakeven analysis which helps in determining sales volume that can help to recover all costs, variable as well as fixed costs.

One of the main issues with CVP analysis is that it is not dynamic in nature. In other words, it assumes same level of costs and sales price irrespective of time duration or range. In given case, if there is a promotion run, then the occupancy must increase beyond 70% and hence, breakeven point will be much sooner. However, this cannot be factored into CVP analysis. Also, it does not account for changes in variable or fixed cost, For example, in given case, if there is sharp increase in grocery prices, it will impact the variable cost which will delay the achievement of breakeven. However, CVP analysis will not factor in such contingencies. Also, there is heavy reliance on number of units or volume as the main factor whereas, in reality, there can be multiple factors that impact a business’s profitability.

The increase in revenue per unit will also lead to increase in contribution margin per unit. Hence, in this case, 

Revenue per Unit = $150

Variable Cost per Unit = $35

Contribution Margin = $150-$35 = $115 per unit (or per service)

Fixed Costs = $40,000

Target Profit = 150,000

Required Units = (Fixed Cost + Target Profit)/Contribution Margin = (40,000+150,000)/115 = 1,652 units (or services). 

Assuming that the 100-room hotel is operational at 70% occupancy for 365 days in a year, this level of 1,652 units (or target profit of $150,000) can be achieved in 24 days. 

Hence, the target profit can be achieved in 24 days instead of 32 days as in previous case. However, the impact of increase in price must be analysed as this may lead to reduced footfall leading to decline in average occupancy. Also, it may defeat the purpose of promotion which is to attract more customers. Perhaps average tariff of competitor’s can be analysed so as to maximize profit and also benefit from the promotional run.

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