You are founder of Paris Corporation. The Company will provide luxury tours Fran
ID: 2484056 • Letter: Y
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: 1) Contract with independent contractor that will operate the tours in the France 2) 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 (A) 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)? (2 pts) (B) What alternative would you choose if you are seeking the alternative: a. Encompassing lower risk? (explain your answer) (.5 pt) b. Higher earnings in 2018 and thereafter? (explain your answer) (.5 pt) (C) What is the key factor that should drive the decision when considering alternative 1 versus 2? (2 pts)
Explanation / Answer
Option of own Operation centre Details Year 2016 Year 2017 Year 2018 No of Passengers per year( with 45 % & 65% growth in 2017 & 2018) 1,500 2,175 3,589 Sales Revenue @ 2700 per passenger 4,050,000 5,872,500 9,689,625 Variable costs Cost of tour @$1500 per passenger = 2,250,000 3,262,500 5,383,125 10% sales commission to travel agents= 405,000 587,250 968,963 Total Variable cost 2,655,000 3,849,750 6,352,088 Contribution Margin 1,395,000 2,022,750 3,337,538 a Contribution Margin/per passenger $ 930.00 $ 930.00 $ 930.00 b Annual Fixed cost 1,000,000 1,000,000 1,000,000 A Break even no of passengers=a/b= 1,075 Net Operating Income= 395,000 1,022,750 2,337,538 Option of operating with contractor Details Year 2016 Year 2017 Year 2018 No of Passengers per year( with 45 % & 65% growth in 2017 & 2018) 1,500 2,175 3,589 Sales Revenue @ 2700 per passenger 4,050,000 5,872,500 9,689,625 Variable costs Cost of tour @$1750 per passenger = 2,625,000 3,806,250 6,280,313 10% sales commission to travel agents= 405,000 587,250 968,963 Total Variable cost 3,030,000 4,393,500 7,249,275 Contribution Margin 1,020,000 1,479,000 2,440,350 a Contribution Margin/per passenger $ 680.00 $ 680.00 $ 680.00 b Annual Fixed cost 150,000 150,000 150,000 Break even no of passengers=a/b= 221 Net Operating Income= 870,000 1,329,000 2,290,350 B a.Considering lower risk , I shall choose the independednt contractor option as the fixed cost involved is mush less and net operating income in intial years are high. b. Considering probability of higher income from 2018 onwards I shall chose option of owning own operating centre as it gives higher net margin at higher operating level. C The key factors that drive the choice of option is the risk appetite of the management. If the management wants to take the risk and is confident that the 2018 level of passengers can be secured and the costs and revenue data will not deviate towards a worse scenario, then only the decision to operate own operating centre can be taken. For a safer policy to start with , the contractor option is better at least till the crucial volume of passengers is reached.
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