13-22 Cost-plus target return on investment pricing. Jason Brady is the managing

Question

13-22 Cost-plus target return on investment pricing. Jason Brady is the managing partner of a business that has just finished building a 60-room motel. Brady anticipates that he will rent these rooms for 15,000 nights next year (or 15,000 room-nights). All rooms are similar and will rent for the same price. Brady estimates the following operating costs for next year:

Variable Operating Costs $3 per room-night

Fixed Costs

Salaries and Wages $177,000

Maintenance of building and pool $38,000

Other operating and administration costs $190,000

Total Fixed Costs $405,000

The capital invested in the motel is $1,500,000. The partnership's target return on investment is 20%. Brady expects demand for rooms to be uniform throughout the year. He plans to price the rooms at full cost plus a markup on full cost to earn the target return on investment.

1. What price should Brady charge for a room-night? What is the markup as a percentage of the full cost of a room-night?

2. Brady's market research indicates that if the price of a room-night determined in requirement 1 is reduced by 10%, the expected number of room-nights Brady could rent would increase by 10%. Should Brady reduce prices by 10%? Show your calculations.

Please show all work for both. Thanks.

Explanation / Answer

Req 1. capital Investment in Motel: $ 1500,000 rate of return: 20% Desired return in $ (1500,000*20%): $ 300,000 Total Cost of 15,000 room rentals: Variable cost (15,000 room nights @$3 per night) 45000 Add: Fixed cost salaries and wages 177000 Maintenance 38000 Other operating and Admin Cost 190000 Total Cost of 15,000 room rentals: 450,000 Add: Desired return 300,000 Total Revenue to be generated from 15,000 room nightss 750,000 Divide: Number of Room Nights 15,000 Price to be charged per room night 50 Markup per centage: Desired profits / Total cost = $300,000 /450,00*100 =66.67% Req 2: Revised Sselling pirce: $ 50-10% =$45 Room Nights: 15,000+10% = 16,500 nights Income Statement: Service revenue (16500 rooms @$45) 742500 Less: variable cost (16500 nights @43) 49500 Contribution margin 693000 Less:Fixed cost salaries and wages 177000 Maintenance 38000 Other operating and Admin Cost 190000 Net Operating income 288000 No The room price shall not be redced.

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