Economics
Maria has a popular B&B in the Orkney Islands and opens 8 months in a year (March-October). Maria has noticed that the number of rooms do not satisfy the increasing demand. The B&B has 30 rooms, with average revenue per occupied room of £45. The actual occupancy is as follows:
|
March
|
April
|
May
|
June
|
July
|
August
|
September
|
October
|
|
70%
|
80%
|
90%
|
100%
|
100%
|
100%
|
95%
|
80%
|
It has been estimated from records that in the months when the hotel is full the potential demand was greater by 30% in June, by 60% in July and August.
Maria is looking into building 3 extra rooms at a cost of £30,000 each. You have to prepare a financial report about the convenience of building which means engaging in construction, equipping the rooms and a full renovation (construction will take place in idle months –November to February-. Fixtures and fittings for each room are estimated at £5,000 and the renovation costs are £30,000. Maria does not give credit and only accepts cash payments.
The operating costs (in £) of running the B&B are as follows:
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Cost (description)
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Total
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% fixed
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% variable
|
|
Maria’s salary
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30,000
|
100%
|
0%
|
|
Permanent staff
|
100,000
|
100%
|
0%
|
|
Casual staff (only Jun-July-Aug)
|
(10% of sales of relevant months)
|
0%
|
100%
|
|
Cost of goods sold (breakfast)
|
(5% of sales)
|
0%
|
100%
|
|
Annual rates
|
15,000
|
100%
|
0%
|
|
Hotel supplies
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(8% of sales)
|
0
|
100%
|
|
Fixed Overheads
|
30,000
|
100%
|
0%
|
|
Variable overheads
|
10% of sales
|
0
|
100%
|
a) Critically evaluate new approaches to budgeting (10 marks).
b) Prepare a cash budget for the hotel after expansion. Expect yearly growth, starting in year 2 of 5% (increase in revenue). Spread all fixed costs evenly over 8 months. Assume that all costs will increase by 3% and revenue will increase by 5% (after Y2, second year after expansion). All purchases for the breakfast are made on credit one month in arrears. All overheads are paid one month in arrears. Annual rates are paid in two equal instalments April and September. Assume that opening cash balance is £ 2,000. (10 marks)
c) Calculate the contribution per room sold (10 marks)
d) Calculate the Break-even point in number of number of rooms sold. Assume that Break-even will be achieved in 3 years. Also assume that costs will increase 3% and revenues will increase 5% every year (see previous task). (10 marks)
e) Define margin of safety and calculate the margin of safety. (5 marks)
f) Calculate ARR, payback, discounted payback, IRR and NPV (3 years). (20 marks) Assuming a cost of capital of 9% and expected growth of 5% assess whether this is a good investment (5 marks). Total 25 marks
g) Define sensitivity analysis and discuss its importance (5 marks) Discuss the effect that a combined drop (sensitivity analysis) of 10% in demand plus an increase in inflation from 3% to 5% will have on payback, discounted payback, NPV and break-even point. Assume that construction costs will not change. Total 20 marks
h) Write a brief conclusion (5 marks)
