What Price Will the Hotel Need to Charge Per Guest Night to Achieve a Break Even - Essay Example

A. What price will the hotel need to charge per guest night to achieve a break even' In order to get the break even point, the first thing to do isto add up all the fixed costs of the hotel. These include the rates, advertising, maintenance, salaries and wages, heat and light, administration and depreciation. Depreciation for renovation is spread over the period of five years, which gives the company a depreciation expense of '2,000,000 a year. The depreciation for the hotel is spread over 50 years, which gives the hotel a depreciation expense of '800,000 per year. All in all, the hotel's fixed costs amount '5,600,000. After the fixed costs are determined, the unit variable costs, or variable costs per person is determined. By adding the variable costs, the computed total amounts to '80. After computing for the fixed and variable costs, the equation for the break even costs can then be computed. break even volume is equal to fixed costs divided by the differences of the unit sales price and the unit variable costs. Since no proportion is given as regards the sales of the hotel whether for single or double occupancy, the 70% occupancy rate of rooms is computed for single occupancy. This gives a break even sales volume of 25480. With the fixed costs being '5600000 and the unit variable costs at '15, computing it algebraically, the unit sales price is '234.78 in order for the hotel to achieve break even. B. The consortium has set a target ROCE of 20%. What price per guest night will need to be charged to achieve this figure' Since the consortium requires 20% ROCE, the assumption that the whole '50 million belongs to shareholder funds, without any other loans to finance it gives a required profit before interest and taxes of '10,000,000 in order to meet the ROCE. After the PBIT has been determined, in order to compute for the unit selling price to achieve it, the hotel can use the break even equation. The PBIT will then be added to the fixed costs. Computing algebraically, the unit sales price in order to generate a PBIT of '10,000,000 is equal to '627.24. C. Assuming they achieve their ROCE target, what will be the NPV and the IRR of the project over the first ten years' The company WACC is 12%. Since depreciation is deducted from the contribution margin as part of the fixed costs, the PBIT figure is not the hotel's annual operating cash flow. In order to get the hotel's annual operating cash flow, the depreciation has to be added back. In reality, where there is presence of taxes, depreciation has some effect on the hotel's total operating cash flow. Since no tax rate is stated, the assumption of a tax-free economy is made. By adding back the depreciation to the PBIT, which is essentially the net income, because of the absence of taxes, the total annual operating cash flow is '12,800,000. After determining the annual operating cash flow of the hotel, the present value of these cash flows is determined. With the horizon of ten years, and the minimum weighted average cost of capital of 12% as the hurdle rate, the present value of the annual operating cash flows amount to '72,322.854.76. After computing for the present value of annual operating cash flow, the initial outlay of '50 million should be deducted to get the net present value. The net present value of this cash flow stream amounts to '22,322,854.76. A positive net present value denotes an internal rate of return which is higher than the hurdle rate, thus it can be safely concluded that the IRR for this project is higher than 12%. The actual IRR of the cash flow stream is 22.13% for the ten year period. D. Evaluate the possibility of a hotel charging '80 per night on Fridays and Saturdays. With Fridays and Saturdays offering a different rate compared to the other days, the capacity has to be revised, under the assumption of full occupancy again. This revision gives a volume of 7280: 2 days for every week, multiplied by 52 weeks, multiplied by 70 rooms. This will constitute one segment of the revenue. For Sundays to Thursdays, the volume is 18,200: the five remaining days multiplied by 52 weeks, multiplied by 70 rooms. This is the new sales forecast for the hotel. After computing for the capacity, the net income or the PBIT can be determined. At '80 per night at Fridays and Saturdays, the hotel's revenue is 582,400. The hotel's revenue for the rest of the days for the rest of the whole year amounts to '11,415,768. The variable cost is computed under the assumption of single occupancy. With this, the hotel's contribution margin is at '11,615,968. After the fixed costs are deducted, the hotel's net income is equal to '6,015,968. After the net income is determined, the depreciation costs should be added back in order to get the total operating cash flow. Adding back ',800,000 to the net income, the hotel's operating cash flow is equal to '8,815,968. This will serve as a basis for the computation of the net present value and the IRR. The present value of the hotel's annual operating cash flows should be computed first, with a hurdle rate of 12% for the horizon of 10 years. The present value is equal to '49,812,185.41. After the present value is determined, the initial outlay of '50million should be deducted. This gives a negative net present value figure of '187,814.69. If the net present value is negative, the internal rate of return must be lower than the hurdle rate. The actual IRR of the project is 11.91%, which is consistent with the negative net present value figure. If the hotel's management bring down the room prices into '80 per night even at Fridays and Saturdays only, since it is so much lower than the hotel's break even unit sales price, the hotel's revenue would definitely suffer. This would result in lower net income, therefore lower operating cash flow, IRR lower than the WACC, and a negative NPV. This is not a good decision from a financial point of view. E. Advise the management of the hotel how they may generate additional revenue. The assumption that 100% of the hotel's sales is dedicated to single occupancy lies in the hotel's capacity, which is 100 rooms only. These 100 rooms, as indicated in the questions can be let as singles or doubles; however since the rooms cannot be shared by two single occupants unknown to each other, the room's capacity cannot be expanded. The only way to expand the capacity is to target consumers who will avail of the double occupancy. By setting a target, for example, 50% of the hotel's sales to be derived from double occupancy, the capacity can be better utilized, with an additional volume of 12,750 yearly. Revising the hotel's advertising and marketing strategy in order to cater to these target consumers would be another way to increase the hotel's revenues. Targeting customers who will avail of the double occupancy will increase the volume; consequently, this will increase the hotel's variable costs. The new sales revenue for the hotel is '16,909,037.6. The new contribution margin amounts to '16,335,737.6, after deducting the new total variable cost amount. This leaves a net income of '10,735,737.6 for the hotel, a net income higher by '735,737.6. Of course, this figure will be lower by a few thousands as the revision in the hotel's marketing strategy will have an impact on its advertising expense; bu increasing its capacity this way is another alternative for the hotel to generate additional revenue. Read More