Make Or Buy Decision For Crystal Hotel Wellness Centre Project Essay.

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.

a) Explain and evaluate the role and importance of financial information in business decision making

b) Apply relevant accounting concepts to simple business scenarios

d) Apply basic costing and budgeting techniques to business decision making

e) Apply capital budgeting techniques to capital investment scenarios

Factors to Consider for Make or Buy Decision

According to the provided information, Crystal Hotel is planning for a Wellness Centre Project, which is to develop a small gym on the hotel roof. For implementing this plan, the hotel has to use certain equipment for completing the work. However, the issue here for the management of the hotel is to select whether to purchase the equipment or rent the same. In this context, Maskell, Baggaley and Grasso (2016) stated that the most significant factors to be considered for undertaking make or buy decision include quantitative analysis like the production costs and the capacity of the business to hire at the desired levels. Therefore, the hotel needs to evaluate the two options based on the provided information and accordingly, it could choose the option, which is deemed to be favourable in terms of cost. The following table would help in analysing the costs associated with the two available alternatives:

From the above table, it is evident that the management of Crystal Hotel has to purchase four types of equipment for carrying out the Wellness Centre Project under buy option. It has been found that the hotel needs to incur a total of $46,624, if it chooses this option. This cost takes into consideration the servicing cost of $600 per year for three years for single equipment that the hotel would purchase to acquire the project and this cost is needed for equipment maintenance (Noreen, Brewer & Garrison, 2014). However, it could earn a portion of the equipment purchased in the form of residual value of 5% of the acquisition cost, which is expected to be generated at the end of the project life. This option could result in certain advantages for Crystal Hotel, which are demonstrated briefly as follows:

• The foremost benefit is that the rights of the equipment would remain with the management of the hotel and it does not have to incur any monthly, quarterly or annual rent, which would have increased its total cost.
• Since the ownership of the equipment remains with the management of Crystal Hotel, it could retain the same for future wellness projects as well.

However, the drawbacks of this option could not be ignored from the hotel perspective and these drawbacks are cited as follows:

• It has been evaluated that for the buy option, Crystal Hotel would have to incur $46,624, which is more than the budget amount of $45,550 of the hotel.
• The hotel has to bear servicing cost for equipment maintenance, as non-servicing of the equipment might minimise their economic lives. Hence, this results in additional cost burden for the hotel.

Crystal Hotel could rent the desired equipment at either monthly, half-yearly or yearly basis. However, since the economic life of the project is three years and annual rent would save additional cost for the hotel, it is assumed that the hotel would consider the annual rent for consideration. It is found that if the hotel decides to rent the needed equipment, it would have to incur a total cost of $35,459. In this case, the hotel has to incur yearly rent for all equipment. The primary advantages of this option for the hotel are discussed as follows:

• The annual rent payments are lower in contrast to the overall cost to be incurred by the management of the hotel, if it decides to purchase the equipment.
• It is not necessary for the management of Crystal Hotel to incur servicing costs separately and thus, it would result in additional time savings for the hotel (Collier, 2015). 

Cost Analysis of Buy Option

However, it is noteworthy to mention that the only disadvantage associated with the rent option of the hotel is that the hotel does not own the equipment and hence, no control could be exercised by the management over the same.

Based on the above discussion, it is recommended to the management of Crystal Hotel to choose the rent option, as it would have to incur lower cost in contrast to the buying option. Moreover, it would result in additional revenue generation and thus, the rent option is deemed to be more favourable for the hotel.

The above figure mainly helps in representing the feasibility of the external membership project, as proposed by the Sales and Marketing Manager of Crystal Hotel. The main cash outflows for this project would be the promotional cost and monthly payments to be made to the in-house trainer and dietician for their services rendered to the hotel and their payments are expected to rise by 3% each year. On the other hand, the revenue for the first year is estimated at $137,360, which would increase by 10% in the subsequent years. In the above table, the net present value (NPV) is computed as $6,276 and a higher NPV is always deemed to be favourable for the organisation. In this context, Baum and Crosby (2014) cited that NPV is the method through which it is possible for any organisation to evaluate the feasibility of a project by determining the profit to be earned from investment. In this case, since the NPV is found to be positive, it is recommended to accept the project, as it would help the hotel in maximising its overall return on investment.

(Source: Business.qld.gov.au, 2018)

CVP analysis is used in ascertaining the impact of changes in volume and cost on the net operating income and net income of an organisation (Kumar, 2016). This analysis enables the management to undertake decisions for setting prices so that adequate profits could be earned for the business. Many organisations and accounting experts use this analysis for undertaking informed decisions regarding the products sold or services rendered (Calderon et al., 2018). In this context, it needs to be mentioned that CVP analysis plays a significant role in managerial accounting more than in financial accounting. For conducting CVP analysis in order to undertake business decisions, certain assumptions are made, which are elucidated briefly as follows:

• The costs could be segregated easily into fixed costs and variable costs from manufacturing, overhead and administrative expenses.
• There is no change in the selling price per unit.
• The activity changes are the only influential dynamics affecting cost.
• The production amount is assumed to be identical with the sales volume (Elmassri, Harris & Carter, 2016).

For Crystal Hotel, CVP analysis carries immense significance, since it is necessary to project the sales levels for reaching the break-even selling point so that it does not encounter any loss. With the help of this analysis, the management of the hotel could project sales revenue that it is capable of generating over the year. Along with this, the method is extremely useful in the hotel planning stage for projecting the service range to be provided by the management for accomplishing the business break-even point (Noreen, Brewer & Garrison, 2014). 

Advantages and Disadvantages of Buy Option

Based on the provided information, it could be observed that the management intends to increase the attractiveness of the hotel by initiating a refurbishment project. The goal is to set additional plants in the hotel lobby for increasing the beauty of the premises, which would help in drawing new customers towards the hotel. The management of the hotel has two alternatives to ensure success of the project. The first option is to hire a professional organisation in order to deliver and maintain the plants and the second option is to purchase the plants and a gardener would be hired for their maintenance. The detailed analysis of both the options is provided as follows:

According to this option, Crystal Hotel needs to incur costs only for a single time for buying the plants to be placed in the lobby of the hotel premises. Moreover, for maintaining the plants, it is necessary for the hotel to appoint a gardener to look after the same. In this case, the total cost that Crystal Hotel has to bear would be $46,624 for three-year period. If the management of the hotel chooses this option, the hotel would have the full rights over the plants and it is possible for them to change the plants and arrangement styles, according to its preference. However, there is drawback associated with the buy option. The management of Crystal Hotel has to incur additional cost, since it needs to appoint a gardener for maintenance (Gibson & Haynes, 2015).

According to this option, Crystal Hotel needs to appoint a specialist organisation for managing the plants in the hotel lobby. In this case, the appointed organisation would charge a particular amount from the hotel. If this option is chosen, the plantation work would be increasingly better, since a specialised organisation is associated with it. The significant advantage of this organisation is that the cost incurred would be lower than the rent option and hence, more revenue would be generated in future. However, the management of Crystal Hotel would not enjoy rights over the plants (Weygandt, Kimmel & Kieso, 2015). The cost to be incurred by the hotel, if the rent option is accepted, would be $35,626.

Based on the above evaluation, it is advised to the management of Crystal Hotel to choose the rent option, as it would help in additional cost savings with slight increase in profit. The goal of the hotel is to reduce the business expenses, which implies the feasibility of the rent option to be selected.

Cost Analysis of Rent Option

In order to enhance the improvement process, Crystal Hotel is planning to invest in an event management software package for managing its various events. It is expected by the management that the new software would help in streamlining processes and minimising the time incurred in booking and quoting events. Moreover, the business efficiency would increase along with rise in revenue irrespective of the type of funding of software package. In this situation, two options are available to the management of the hotel out of which the most favourable alternative would be selected (Almazan, Chen & Titman, 2017). These two options are compared with the help of the below-stated calculation:

For this option, Crystal Hotel has to incur $6,900 for acquiring the software and it has to pay an upgrade fee of $300 in the first year, which would increase by 3% each in the next two years. The benefit from this option is that the hotel has to bear a single down payment only for obtaining licence and upgrade cost. The hotel would have the full right over the software until the expiry of the licence. However, the cost to be incurred is higher for this option in comparison to the subscription alternative (Andor, Mohanty & Toth, 2015).

In this option, a subscription fee of $181 per month and it is expected to increase 3% each in the later two years. After combining the fee amount, the hotel has to incur $6,713, which is lower than the subscription option of $7,827. The benefit from this option is that the hotel would save in terms of cost compared to the other option. However, since the software would be taken based on subscription, modifications in the software could not be made due to absence of full ownership (Baum & Crosby, 2014). 

Based on the two alternatives in the hands of the management of Crystal Hotel, subscription plan is a better alternative, as it could minimise its initial investment and additional profit could be generated.

(Source: Melbourne.vic.gov.au, 2018)

According to the above table, CVP analysis is carried out for analysing the break-even point and cost margin in order to attend the corporate meeting of the organisation. The rendered services ate to be evaluated through break-even analysis for projecting the sales level required to be achieved by the business for covering fixed expenses without incurring any loss or making any profit. In this case, the break-even unit is obtained as $1,000 units. With the assistance of CVP analysis, it becomes easier for the management of an organisation in undertaking considerable decisions about the sales level or service units for accomplishing neither profit nor loss situation (Salas & Campos, 2016).

References:

Almazan, A., Chen, Z., & Titman, S. (2017). Firm Investment and Stakeholder Choices: A Top?Down Theory of Capital Budgeting. The Journal of Finance, 72(5), 2179-2228.

Andor, G., Mohanty, S. K., & Toth, T. (2015). Capital budgeting practices: A survey of Central and Eastern European firms. Emerging Markets Review, 23, 148-172.

Baum, A. E., & Crosby, N. (2014). Property investment appraisal. John Wiley & Sons.

Business.qld.gov.au. (2018). Types of advertising | Business Queensland. Retrieved 21 August 2018, from https://www.business.qld.gov.au/running-business/marketing-sales/marketing-promotion/advertising/types

Calderon, T., Hesford, J. W., Mangin, N., & Pizzini, M. (2018). Sunrise Hotels: An integrated managerial accounting teaching case. Journal of Accounting Education.

Collier, P. M. (2015). Accounting for managers: Interpreting accounting information for decision making. John Wiley & Sons.

Elmassri, M. M., Harris, E. P., & Carter, D. B. (2016). Accounting for strategic investment decision-making under extreme uncertainty. The British Accounting Review, 48(2), 151-168.

Gibson, J. L., & Haynes, W. W. (2015). Accounting in small business decisions. University Press of Kentucky.

Kumar, R. (2016). Break Even Analysis: A Glance. International Journal of Research in Finance and Marketing, 6(2), 175-193.

Maskell, B. H., Baggaley, B., & Grasso, L. (2016). Practical lean accounting: a proven system for measuring and managing the lean enterprise. Productivity Press.

Melbourne.vic.gov.au. (2018). Retrieved 21 August 2018, from https://www.melbourne.vic.gov.au/SiteCollectionDocuments/melbourne-event-planning-guide.pdf

Noreen, E. W., Brewer, P. C., & Garrison, R. H. (2014). Managerial accounting for managers. New York: McGraw-Hill/Irwin.

Noreen, E. W., Brewer, P. C., & Garrison, R. H. (2014). Managerial accounting for managers. New York: McGraw-Hill/Irwin.

Quattrone, P. (2016). Management accounting goes digital: Will the move make it wiser?. Management Accounting Research, 31, 118-122.

Salas, O. A., & Campos, M. J. S. (2016). Finance and Accounting for Managers (Vol. 28). Profit Editorial.

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & managerial accounting. John Wiley & Sons.