Sales Price
Selling price x Contribution
= 150 x 97
= 14,550
Maximum income = £150 x 600 = 90,000 (with 600 being the total number of guests.)
90,000 – 14,550
= £75,450
£75,450
600
= 125.75
This tells us that £125.75 can be offered to residents to break even.
In order to check that the resulting answer is in fact correct I will total all costs and, if the my original answer is correct, they should equal £75,450
Fixed costs = £43,650
Variable costs = £53 x 600 (number of guests)
= £31,800
£43,650 + £31,800 = £75,450
-£75,450
600 =£125.75 (per guest)
Therefore in order for the charity to break even a charge of £125.75 can be given to each person.
C. The charity can extend its accommodation by renting an adjoining property, this would allow a further 10 guests. The only increase in cost would be yearly fixed rent of £14,550.
Discuss this situation with appropriate calculations and state if this would in your opinion be a good decision.
The following table represents a profit statement to show the effect of an increase in the number of guests from 20 to 30:
The major advantage of renting an adjoining property and hence taking on a further 10 guests would be the significant increase in revenue. Should the charity stand to make a loss as a result of increasing the number of guests by 10 then for obvious reasons there would be no point in making the change in question.
-The signal increase in cost would be seen in the yearly fixed rent of £14,550 so the charity will need to take this into account.
- Selling price = £150
10 guests x 30 weeks = 300 guests
300 guests x £150 = £45,000 – This is the amount the charity would stand to receive should they get the maximum number of guests in the home.
-Fixed costs = £14,550
Variable costs = 53 x 10 x 30 = £15,900
Profit = 45,000 – 14,550 – 15,900 = £14,550
As you will have seen from the above table, should the charity decide to increase the number of guests by 10 then they would stand to receive twice the amount in profit (£14,550 to £29,100).
With the extra costs, due to the increase in number of guests, the break even point (currently at 15 guests per week) will also increase.
Break even point = Fixed Costs = 14,550
Contribution per Unit 97
= 150 Guests
150 guests
30 weeks
= an increase of 5 guests (per week)
This increase of 5 guests onto the 15 previously needed to break even brings a total of 20 guests per week needed to break even when the charity has the capabilities of holding 30 guests.
-Breakeven sales revenue = 150 x 20 x 30
= £90,000
-Expected Sales Revenue = 150 x 30 x 30
= £135,000 (over 30 weeks)
-Percentage Margin of Safety = Expected Sales – Breakeven Sales
Expected Sales
= (135,000 – 90,000)
135,000
= 0.33 x 100
= 33%
From this answer we can see that , should the charity fill all vacancies within the holiday home, the new margin of safety will act as a greater advantage than the previous one to the charity as sales can fall by 33% and under until the charity even begin to make a loss. In comparison, previously the charity could only allow sales to fall by 25% and under before a loss was made.
There are many positive things that would come out of the charity increasing the capacity of the holiday home to 30 guests. The charity has been given a better chance of breaking even due to the 8% increase in the margin of safety. Also if only half of the 10 rooms are vacated then a profit would still be reached. Also with the greater number of vacancies within the holiday home a better reputation will be gained due to less people having to be refused due to lack of spaces.
However, as with most business decisions there is a down side to the investment. If the charity fails to vacate 50% or more of the extra 10 rooms they stand to make a loss. Also the introduction of a further 10 rooms leads to a greater need for further employees which would be an extra financial cost for the charity. The fixed cost of £14,550 will fail to be covered and such continuing loss could lead to bankruptcy of the charity.
Another problem can be seen within the breakeven analysis which works on a number of limitations. An example of these limitations can be seen by the breakeven analysis working on the basis that the fixed cost remains constant throughout. However the likely hood of this occurring is very low due to such variables as price levels effecting sales revenue and costs. Breakeven analysis could therefore end up being damagingly misleading to the charity should management fail to take into account significant changes. Further limitations to the breakeven analysis can be seen by the fact that it is only effective in the short term due to the effect of volume on such variables as cost, profit and revenue. Therefore breakeven can not be used long term because there are many variables other than volume that need to be taken into consideration as they will affect the fixed costs.
After taking all the above into account, the most effective variable is the level of demand as this will act as a stepping stone to all other aspects of the charity. If the charity was just about breaking even at its original capacity of 20 guests then the introduction of a further 10 guests would be a mistake as the demand for these further vacancies would be low and fixed costs would not be covered. However, this works both ways, should the demand be very high as well as the number of guests significantly above the breakeven point at the charities original capacity of 20 guests then it would be seen as a sound business investment to increase this to 30 guests.
Bibliography
- Drury, C (1998), Costing an Introduction, London, Thomson.
