You are founder of Paris Corporation. The Company will provide luxury tours Fran

Question

You are founder of Paris Corporation. The Company will provide luxury tours France. The Company has its headquarters in Boston and is considering it operating structure in the France. The alternatives being considered include: Contract with independent contractor that will operate the tours in the France Establish an operations center in the France to run the tours by Company personnel The management team has developed the following information for you to consider: Although demand is uncertain, it is expected to be for 10 passengers on each of the 150 tours being offered for the 2016; sales growth is expected to be 45% in 2017 and 65% in 2018; continued, although more moderate growth is expected in years thereafter Tour price is $2,700 per person excluding airfare which passengers are responsible for obtaining on their own Fixed costs of the Company's Boston headquarters for the coming year is estimated at $1,000,000 Tours will be sold through travel agents who are paid a 10% commission The independent contractor would charge a $150,000 annual fixed payment along with a per passenger fee of $1,750 The annual fixed cost to run an operations center in France would be $1,000,000 and the per passenger cost to run the tours would be $1,500 The maximum capacity under alternatives 1 & 2 is 10,000 passengers What would be the annual breakeven level of activity in terms of number of passengers for each of the 2 alternatives being considered (e.g., contract with an independent contractor to run the tour or establish an operations center in France to run the tours by Company personnel)? What alternative would you choose if you are seeking the alternative: Encompassing lower risk? (explain your answer) Higher earnings in 2018 and thereafter? (explain your answer) What is the key factor that should drive the decision when considering alternative 1 versus 2?

Explanation / Answer

A)

The break even point in number of passengers is better in the contract alternative. Running an operating division in France woul have more cost and the break even point is higher. Moreover, it involves an operating loss in 2016.

B)Considering the risk factor, if the firm is risk averse, then the option of running an operating division would be more favourable. The risk of contractor not doing the business and economic conditions in France which would affect the contract business if it is at a higher rate and if the management is not able to digest such level of risk, it is better to opt fot the operating division. If higher rate of return are available after 2018, then the operating loss of running the operating division can be offset with those higher returns.

C) The key factor in this decison is contribution per passenger. Since the maximum number of passengers that can be contained is 10000, the per passenger contribution is the key decision factor.

On Contract Nature 2016 2017 2018 Number of tours 150 218 359 Passenger per tour 10 10 10 Total Passengers 1500 2175 3589 Cost Headquarters cost Fixed -1000000 -1000000 -1000000 Travel Agent commission Variable -40500 -58725 -96896 Contractor charge Fixed -150000 -150000 -150000 Contractor passenger fee Variable -2625000 -3806250 -6280312.5 Revenue Variable 4050000 5872500 9689625 Contribution Variable 1384500 2007525 3312416.25 Operating Profit 234500 857525 2162416.25 Contribution per passenger 923 923 923 Total fixed Cost -1150000 -1150000 -1150000 Break even Point passengers                             1,246                             1,246                        1,246

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