Skyview Manor

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Skyview 1 Calculating the break-even occupancy level requires splitting the costs in Exhibit 1 into the fixed and variable components: a) Variable Costs: Cleaning supplies $ 1,920 Linen service $13,920 1/2 Misc. expense $ 3,657 $19,497 b) Per Occupied Room Night = $19,497 ÷ 7,680 (120 80 80%) = $2.54 c) Contribution Margin: Average revenue $160,800 ÷ 7,680 = $20.94 Revenue - Variable Cost = $20.94 -$2.54 = $18.40 d) Fixed Costs: Total Costs - Variable Costs = Fixed Costs $138,410 - $19,497 = $118,913 e) Break Even = $118,913 / $18.40 = 6,463 room nights Per night (÷ 120) = 54 rooms (68% occupancy) Question 1— On average, how many rooms must be rented each night in season for the hotel to breakeven?

Transcript of Skyview Manor

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Calculating the break-even occupancy level requires splitting the costs in Exhibit 1 into the fixed and variable components:a) Variable Costs:

Cleaning supplies $ 1,920Linen service $13,9201/2 Misc. expense $ 3,657

$19,497b) Per Occupied Room Night = $19,497 ÷ 7,680 (120 80 80%)

= $2.54c) Contribution Margin:

Average revenue $160,800 ÷ 7,680 = $20.94Revenue - Variable Cost = $20.94 -$2.54 = $18.40

d) Fixed Costs:Total Costs - Variable Costs = Fixed Costs$138,410 - $19,497 = $118,913

e) Break Even = $118,913 / $18.40 = 6,463 room nightsPer night (÷ 120) = 54 rooms (68% occupancy)

Question 1— On average, how many rooms must be rented each night in season for the hotel to breakeven?

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The easiest way to make the calculation is to calculate the change in Contribution Margin (CM) since fixed costs will not change.

Lost CM8 rooms 34 weekend nights (120 2/7 = 34) $18.40 = $5,005.Added CM72 rooms 34 nights $5 = $12,240.Net Change$12,240 - $5,005 = $7,235 more profit (before tax)The breakeven number for lost rooms per night is give by:

X = Breakeven lost roomsX • $18.40 = (80 - X) $5

$18.4X + $5X = $400$23.4X = $400

X = 17

The price increase is a good idea as long as we can rent at least 63 rooms per weekend night.

Question 2 — The hotel is full on weekends in the ski season. If all room rates were raised $5 on weekend nights, but occupancy fell to 72 rooms instead of 80, what is the revised profit before taxes for the year, per Exhibit 1?

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1) RevenueSingle = $10, Double = $15, weighted average = $14.

2) Variable Cost, from question 1 = $2.54/room night

3) Contribution MarginRevenue - Variable Cost = #14 - $2.54 = $11.46/room night

Question 3 — Contribution Margin in the Off Season

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1. Do nothing.2. Stay open—no advertising—no pool3. Stay open—advertise—no pool4. Stay open—no advertising—pool only5. Stay open—advertise—pool only6. Stay open—no advertising—pool and bubble7. Stay open—advertise—pool and bubble

Advertise

No

Yes

No YesBubble

Pool

No

(2)

(3)

(4) (6)

(5) (7)

Yes

Question 4 — The Options

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Incremental Fixed Expenses

DECISION Repair Insur- Mrs. K Adv. Pool Bubble Pool Ex. Phone Elect. Maids

ALTERNATIVE ance Dep'n Dep'n

(a) (b) (c) (d) (e) (f) (g)

Total $2000 $500 $4200 $4000 $5000 $3000 4200 or $720 $3675 4320

88000 1. Status Quo

$15,415 2. adv no, pool no

$19,415 3. adv yes, pool no

$24,615 4. adv no, pool yes, bubble no

$28,615 5. adv yes, pool yes bubble no

$32,215 6. adv no, pool yes bubble yes

$36,215 7. adv yes, pool yesbubble yes

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(a) 35 weeks x $100/week @ $3500 x 1.2 = $4200(b) 25000/5 = $5000(c) 15000/5 = $3000(d) Pool expense, if only open off season,

and no bubble= Lifeguard (3x400)= $ 1200Insurance & Taxes 1200Maintenance 1800 $4200

Pool expense if opened year round with bubble = From above $ 4200

Additional Lifeguard 3600Heating 1000 $8800

(e) (30 rooms) ($3 per room) = $90 x (8 months) = $720

(f) Total Utility Cost, from the case $6360less Phone Expense $(1560) = [(290x4) + (50x8) = $1,560]= Electricity Expense $4800 (for 9600 available rooms)For 7350 available rooms = 7350/9600 x $4800 = $3,675

(g) We pay four maids during the season for 7,680 occupied nights (120x80x.8) which is 1920 rooms per maid. Each maid cleans 16 rooms (average) during the week and 20 rooms on the weekend. With only 30 rooms open off-season and only 40% maximum occupancy expected—12 rooms—only one extra maid is needed. The cost is $15/day x 240 days = $3600; $4320 with fringes.

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Question 5 — Break-even Occupancy Rates

Decision Alternatives (same order as for Q2 and Q3)

Available room days = 30 x 245 = 7350

1) Not Applicable

2) 15415/11.46 = 1345 1345/7350 = 18%

3) 19415/11.46 = 1694 1694/7350 = 23%

4) 24615/11.46 = 2148 2148/7350 = 29%

5) 28615/11.46= 2497 2497/7350 = 34%

6) 32215/11.46 = 2811 2811/7350 = 38%

7) 36215/11.46 = 3160 3160/7350 = 43%

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Question 7 — Investment

1. Depreciation of $30,000 with a 15 year life implies buildings & furnishings of $450,000.

2. Interest expense of $21,716 for the first year at 5% interest implies an average one year old mortgage balance of about $434,000 [beginning balance (new mortgage) of $440,000 and ending balance of $430,00]. Assuming a normal mortgage limit of 80% of value, the property is worth about $550,000.

3. This would imply about $100,000 for non-depreciable land (550,000-450,000), which seems reasonable.

4. There is probably very little working capital investment here—no receivables, very little inventory, and perhaps some modest accruals for wages, payroll taxes and miscellaneous bills. We would estimate a net of about zero, except for cash.

5. The cash balance would have to be large enough to support the float on day to day operations over the year. Exhibit 1 here is a rough estimate of cash flows over the twelve months. The business would need about $55,000 in cash at the end of a season (April 1) to carry it through until December (including a 10% cushion). From December to March, the business probably needs about $20,000 in cash at any time (roughly, 1 month’s payments plus a 10% cushion). Thus, at March 31 we would estimate a cash balance of probably $55,000 with an average monthly balance closer to $30,000.

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Season Out of Season (Dec-March) (April-Nov)

Revenues 160.8Expenses

Manager 5.0 10.0Wife 2.4Clerk 2.9Maids 7.2 ____ Total Payroll 17.5 10.0Fringes 3.5 2.0Property Tax 2.0 2.0Insurance 1.0 2.0Repair and Maintenance 5.0 12.2Cleaning Supplies 2.0Utilities 5.4 1.0Linen Service 13.9Miscellaneous 5.6 1.7Mortgage (31,700) 10.7 21.0Income Tax 10.7 ____ Total 77.5 51.7 NET 83.3 (51.7)

Net Earnings 11.6 + Depreciation 30.0- Mortgage Principal (10.0) 31.6

Exhibit 1Estimated Cash Flows Summary for a Year

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Skyview Manor Balance Sheet

Assets Equities

Cash 55,000 Accruals 1,000Accounts Receivable 0Inventory (Supplies) 1,000Buildings & Equip. -Gross 450,000 Mortgage 430,000

-Deprn. (30,000)420,000

Land 100,000 Equity 145,000*TOTAL 576,000 576,000

* Beginning Investment $165,000 (cash 55+20% of Prop.=$110) + Earnings 12,000 - “Dividend” (32,000) Ending Investment $145,000

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Earnings

Profit after taxes for the first year was $11,600, after deducting $30,000 of depreciation. If we make the very reasonable assumption (for commercial real estate) that the Repairs and Maintenance budget of $17,000 keeps the building in good shape, then only the depreciation on Equipment is a real expense.

Assuming this is $5,000 of the $30,000, the remaining $25,000 is just a “tax shelter,” courtesy of U.S. tax laws. Real earnings of the business, then, are more like $37,000 (~$12,000 + ~$25,000) per year.

Assuming that it would be possible to keep the property mortgaged at 80% of value, all the time, and that the value does not drop below the $550,000 purchase price, the owners should be able to take out $37,000 a year as discretionary income for the next 15 years.

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Return on Investment

The purchase price of $550,000 represents a 11.5 multiple on the “unlevered annual free cash flow” of the business which is about $48,000 ($37,000 from above plus the after tax equivalent of the interest expense, which is about $11,000). This is in the high end of the old “rule of thumb” range (8 to 12 times), suggesting this is a good commercial property.

The earnings calculations here confirm this. The $37,000 levered return on the $165,000 levered investment is about 22% after taxes. This is a good, solid return on a business we would consider to be well above average in risk. Remember that in 1963, no one was yet aware of how big a “boom” was coming in the ski industry over the next 20 years. In short, we see the Skyview Manor as a “good return” business for the owners but subject to high business risk. The combination of high business risk and high operating leverage mean that it is very important for the owners to do everything possible to protect and grow their business.

This analysis definitely sets a particular context for evaluating the swimming pool investment and the “off season” clientele proposal.