5-55 Pricing at the Grand Canyon Railway (Horngren, Sundem, Schatzberg, & Burgst
ID: 2418633 • Letter: 5
Question
5-55 Pricing at the Grand Canyon Railway (Horngren, Sundem, Schatzberg, & Burgstahler, 2012, p. 217-218) Suppose a tour agent approached the general manager of the Grand Canyon Railway with a proposal to offer a special guided tour to the agent’s clients. The tour would occur 20 times each summer and be part of a larger itinerary that the agent is putting together. The agent presented two options: (a) a special 65-mile tour with the agent’s 30 clients as the only passengers on the train, or (b) adding a car to an existing train to accommodate the 30 clients on an already scheduled 65-mile tour. Under either option, Grand Canyon would hire a tour guide for $200 for the trip. Grand Canyon has extra cars in its switching yard, and it would cost $40 to move a car to the main track and hook it up. The extra fuel cost to pull one extra car is $.20 per mile. To run an engine and a passenger car on the trip would cost $2.20 per mile, and an engineer would be paid $400 for the trip. Depreciation on passenger cars is $5,000 per year, and depreciation on engines is $20,000 per year. Each passenger car and each engine travels about 50,000 miles a year. They are replaced every 8 years. The agent offered to pay $32 per passenger for the special tour and $15 per passenger for simply adding an extra car. 1 Which of the two options is more profitable to Grand Canyon? Comment on which costs are irrelevant to this decision. 2 Should Grand Canyon accept the proposal for the option you found best in number 1? Comment on what costs are relevant for this decision but not for the decision in number 1. 5-55 Pricing at the Grand Canyon Railway (Horngren, Sundem, Schatzberg, & Burgstahler, 2012, p. 217-218) Suppose a tour agent approached the general manager of the Grand Canyon Railway with a proposal to offer a special guided tour to the agent’s clients. The tour would occur 20 times each summer and be part of a larger itinerary that the agent is putting together. The agent presented two options: (a) a special 65-mile tour with the agent’s 30 clients as the only passengers on the train, or (b) adding a car to an existing train to accommodate the 30 clients on an already scheduled 65-mile tour. Under either option, Grand Canyon would hire a tour guide for $200 for the trip. Grand Canyon has extra cars in its switching yard, and it would cost $40 to move a car to the main track and hook it up. The extra fuel cost to pull one extra car is $.20 per mile. To run an engine and a passenger car on the trip would cost $2.20 per mile, and an engineer would be paid $400 for the trip. Depreciation on passenger cars is $5,000 per year, and depreciation on engines is $20,000 per year. Each passenger car and each engine travels about 50,000 miles a year. They are replaced every 8 years. The agent offered to pay $32 per passenger for the special tour and $15 per passenger for simply adding an extra car. 1 Which of the two options is more profitable to Grand Canyon? Comment on which costs are irrelevant to this decision. 2 Should Grand Canyon accept the proposal for the option you found best in number 1? Comment on what costs are relevant for this decision but not for the decision in number 1.Explanation / Answer
Particulars
Special 65 Mile tour as agents clients as only passengers
Adding a car to an existing train to accommodate the 30 clients on an already scheduled 65-mile tour
Revenue from tour ( $ 32 * 30) ( $15 * 30 )
960
450
Additional engine charges to run a special tour ( $2.20*65 )
143
0
Moving cost of extra cars
0
40
Extra fuel cost ( 0.20 $ * 65 )
0
13
Profit from Operations ( Per Trip )
817
397
Irrelevant Costs
Irrelevant costs are the costs which are not relevant to the decision making process as either they are incurred irrespective of the decision taken or They are sunk costs.
Hiring chargers for tour guide
Irrelevant cost As Hiring charges will be paid by grand canyon railway irrespective of the decision taken by them
Depreciation
Non-cash expenses such as depreciation are not relevant because they do not affect the cash flows of a business
Engineer charges
Common costs. Engineer would be paid $400 for trip irrespective of the option
Grand Canyon should accept the decision in proposal 1 as profit per trip is greater in proposal 1.
The costs Relevent for decision making
Costs
Relevancy
Additional engine charges to run a special tour
If special 65 mile tour is specifically made, then additional engine charges will be incurred @ $2.2 per mile
Moving cost of extra cars
To bring in an extra car from the garage the moving cost which is exclusive for decision 2 is relevant
Extra fuel cost
Extra fuel cost for an additional car is relevant as same is not incurred for Decision 1
Particulars
Special 65 Mile tour as agents clients as only passengers
Adding a car to an existing train to accommodate the 30 clients on an already scheduled 65-mile tour
Revenue from tour ( $ 32 * 30) ( $15 * 30 )
960
450
Additional engine charges to run a special tour ( $2.20*65 )
143
0
Moving cost of extra cars
0
40
Extra fuel cost ( 0.20 $ * 65 )
0
13
Profit from Operations ( Per Trip )
817
397
Irrelevant Costs
Irrelevant costs are the costs which are not relevant to the decision making process as either they are incurred irrespective of the decision taken or They are sunk costs.
Hiring chargers for tour guide
Irrelevant cost As Hiring charges will be paid by grand canyon railway irrespective of the decision taken by them
Depreciation
Non-cash expenses such as depreciation are not relevant because they do not affect the cash flows of a business
Engineer charges
Common costs. Engineer would be paid $400 for trip irrespective of the option
Grand Canyon should accept the decision in proposal 1 as profit per trip is greater in proposal 1.
The costs Relevent for decision making
Costs
Relevancy
Additional engine charges to run a special tour
If special 65 mile tour is specifically made, then additional engine charges will be incurred @ $2.2 per mile
Moving cost of extra cars
To bring in an extra car from the garage the moving cost which is exclusive for decision 2 is relevant
Extra fuel cost
Extra fuel cost for an additional car is relevant as same is not incurred for Decision 1
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