You are founder of Paris Corporation. The Company will provide luxury tours Fran
ID: 2722714 • 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
paris co Alternative -Contract with Tour opeartor Own Opeartions revenue per passesnger 2,700.00 2,700.00 2,700.00 Variable cost per passenger Travel agent commission 270 270 Per passenger cost 1,750.00 1,500.00 Total Variable cost 2020 1,770.00 Contribution margin per passanger 500.00 750.00 Fixed cost 100,000.00 1,000,000.00 Break even in non of passengers 200.00 1,333.33 Expect no of passengers 2018 3,825.00 Income statement 2018 Sales Revenue 9,562,500.00 9,562,500.00 Variable cost 7,650,000.00 6,693,750.00 Contribution Margin 1,912,500.00 2,868,750.00 Less Fixed costs 100,000.00 1,000,000.00 Net operating income 1,812,500.00 1,868,750.00 Alternative -Contract with Tour opeartor Own Opeartions A Break even in non of passengers 200.00 1,333.33 B a. Considering Low risk , the option of contract with independent operator is better as the BEP passeneger level is quite low as fixed costs are low and chance of loss minimal. b. Considering 2018 level activity and taking higher potential earning level into account, setting up company's own operating structure will be profitable as from 2018 onwards projected earning , the net oprating profit will be more in setting up own opearting structure in London. C While deciding option 1 vs 2 , the main criteria would be the probability of passenger no increase in future. If the passenger no grows as per projection, the opening of own opearting sturucture in London pays off, it the growth is lower , it is better to operate through contract. Also the risk appetite of the company and the cash flow to support the high fixed costs of second option for initial two years would be crucial for decision making.
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