Skyview 1
Question 1— On average, how many rooms must be rented each night in season for the hotel to breakeven? 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)
Skyview 2
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? The easiest way to make the calculation is to calculate the change in Contribution Margin (CM) since fixed costs will not change. Lost CM 8 rooms 34 weekend nights (120 2/7 = 34) $18.40 = $5,005. Added CM 72 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 rooms X • $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.
Skyview 3
Question 3 — Contribution Margin in the Off Season 1) Revenue Single = $10, Double = $15, weighted average = $14. 2) Variable Cost, from question 1 = $2.54/room night 3) Contribution Margin Revenue - Variable Cost = #14 - $2.54 = $11.46/room night
Skyview 4
Question 4 — The Options 1. 2. 3. 4. 5. 6. 7.
Do nothing. Stay open—no advertising—no pool Stay open—advertise—no pool Stay open—no advertising—pool only Stay open—advertise—pool only Stay open—no advertising—pool and bubble Stay open—advertise—pool and bubble Pool No
Yes Bubble No Yes
(2)
(4)
(6)
(3)
(5)
(7)
No Advertise
Yes
Skyview 5
Incremental Fixed Expenses DECISION ALTERNATIVE
Repair
Insurance
Mrs. K
$2000
$500
(a) $4200
$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
Total 0
Adv.
$4000
Pool Dep'n (b) $5000
Bubble Dep'n (c) $3000
Pool Ex. Phone
Elect.
Maids
(d) 4200 or 8800
(e) $720
(f) $3675
(g) 4320
1. Status Quo
$36,215 7. adv yes, pool yes bubble yes
Skyview 6
(a) (b) (c) (d)
35 weeks x $100/week @ $3500 x 1.2 = $4200 25000/5 = $5000 15000/5 = $3000 Pool expense, if only open off season, and no bubble= Lifeguard (3x400)= $ 1200 Insurance & Taxes 1200 Maintenance 1800 $4200 Pool expense if opened year round with bubble = From above $ 4200 Additional Lifeguard 3600 Heating 1000 $8800
(e) (30 rooms) ($3 per room) = $90 x (8 months) = $720 (f) Total Utility Cost, from the case $6360 less 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.
Skyview 7
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%
Skyview 8
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.
Skyview 9
Exhibit 1 Estimated Cash Flows Summary for a Year
Revenues Expenses Manager Wife Clerk Maids Total Payroll Fringes Property Tax Insurance Repair and Maintenance Cleaning Supplies Utilities Linen Service Miscellaneous Mortgage (31,700) Income Tax Total NET
Season (Dec-March) 160.8
Out of Season (April-Nov)
5.0 2.4 2.9 7.2 17.5 3.5 2.0 1.0 5.0 2.0 5.4 13.9 5.6 10.7 10.7 77.5 83.3
10.0
Net Earnings 11.6 + Depreciation 30.0 - Mortgage Principal (10.0)
____ 10.0 2.0 2.0 2.0 12.2 1.0 1.7 21.0 ____ 51.7 (51.7)
31.6
Skyview 10
Skyview Manor Balance Sheet Assets Cash Accounts Receivable Inventory (Supplies) Buildings & Equip. -Gross -Deprn. Land TOTAL
Equities 55,000 0 1,000 450,000 (30,000) 420,000 100,000 576,000
* Beginning Investment $165,000 (cash 55+20% of Prop.=$110) + Earnings 12,000 - “Dividend” (32,000) Ending Investment $145,000
Accruals
1,000
Mortgage
430,000
Equity
145,000* 576,000
Skyview 11
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.
Skyview 12
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.
