Question #1. 6.

0 Marks
A recently built hotel of 60 rooms expects to have 12,500 room-night available to generate
revenues. All rooms are similar and will rent for the same price. The operating costs for the first
year of operations are as follows:
Variable operating costs $10 per room-night
Manager’s salary $80,000
Employees’ wages $50,000 per employee
Average employees needed 3
Administrative costs $10,000
Building maintenance $20,000
Other fixed operative costs $40,000

The capital invested in the hotel is 1 million. The manager’s target return on investment is 20%
and he expects demand for rooms to be about uniform throughout the year. He plans to price the
rooms at full cost (i.e. total costs, which are variable plus fixed) plus a markup on full cost to
earn the target return on investment.

Required:
Show all supporting calculations in your answer.

a. What price should the Manager charge for a room-night, using a capacity utilization rate of
12,500 rooms? (2.5 marks)

b. The manager’s market research indicates that if the price of a room-night determined in
requirement 1 was reduced by 10%, the expected number of room-nights the hotel could rent
would increase by 10%. Should the manager reduce the prices by 10%? Show all computations.
If you exclude any amounts in your calculations you must state why they are excluded to earn
marks. (3.5 marks)

Page 1 of 10
Answer a.: 2.5 marks
Target selling price:
Estimated sales (12,500 x ?) ?
Costs:
Variable ($10 x 12,500) $125,000
Fixed costs
Manager salary $ 80,000
Employees wages $150,000
Administrative costs $ 10,000
Building maintenance $ 20,000
Other fixed operative costs $ 40,000
Total fixed costs 300,000

Total costs 425,000

Desired return: 20% of $1,000,000 200,000

To earn a target return based on volume of 12,500 rooms, total revenue needs to be:
$200,000 + 425,000 = 625,000
Amount to charge per room is:
625,000/12,500 rooms = $50 per night

Alternative format:
Target operating income = target return on investment x invested capital
Target operating income 20% of $1,000,000 $200,000
Total fixed costs (see note 1) $300,000
Target contribution margin $500,000

Target contribution per room (500,000 / 12,500) $40

Add variable costs per room $10
Price to be charged per room $50

Proof:
Total room revenues ($50 x 12,500 rooms) $625,000
Total costs:
Variable ($10 x 12,500 rooms) $125,000
Fixed $300,000
Operating income $200,000

Note 1: Fixed costs

Manager salary: $ 80,000
Employees wages: $150,000
Administrative costs: $ 10,000

Page 2 of 10
Building maintenance: $ 20,000
Other fixed operative costs: $ 40,000
Total fix costs: $300,000

Answer b: 3.5 marks

Key points: student used CM and compared CM under old pricing to CM under new pricing. FC are
irrelevant since they will not change.

CM under new policy:

If price is reduced by 10%, the number of rooms that could be rent would increase by 10%
The new price per room would be 90% of $50 = $45
The number of rooms expected to rent is 110% of 12,500 = 13,750
The contribution margin per room would be $45 - $10 = $35
Contribution margin $35 x 13,750 = $481,250

CM under old policy:

($50 per room per night - $10 variable cost) x 12,500 = 500,000

Since the contribution margin at the reduced price of $45 ($481,250) is less than the contribution margin
at a price of $50 ($500,000), the manager should not reduce the price of the rooms. Note that the fixed
costs of $300,000 will be the same under the $50 and the $45 price alternatives and are hence irrelevant to
the analysis.

Difference in favour of old policy:

$500,000 - $481,250 = $18750

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Question #2 (5 marks)
Collyer Product Inc., has a Valve Division that manufactures and sells a standard valve as
follows:

Maximum capacity in units 100,000

Selling price to outside customers on the intermediate market $30
Variable costs per unit $16
Fixed costs per unit (based on capacity of 100,000 units) $9

The company has a Pump Division that could use this valve in the manufacture of one of its
pumps. The Pump Division is currently purchasing 10,000 valves per year from an overseas
supplier at a cost of $29 per valve.

On internal sales $3 in variable costs are avoided, due to reduced selling costs.

Required:
Show all computations for each of the required.

a). Assume that the Valve Division has idle capacity to handle all of the Pump Division’s
needs. Calculate the minimum transfer price between the two divisions.

b). i) Assume that the Valve Division is selling all that it can produce to outside
customers on the intermediate market (i.e. it has no idle capacity). What should
the transfer price be between the two divisions from a company wide
perspective (i.e. the minimum transfer price)?

ii). Calculate which is more advantageous in total for the company as a whole –
Pump division obtaining the valve from the Valve Division or from buying it
externally. (Again assume that the Pump Division can sell all of its output to the
external market.)

c). Assume that the Valve Division is currently operating at 95% of maximum capacity.
What should the minimum transfer price per unit be?

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Solution:
(a) Because the Valve Division has idle capacity, it does not have to give up any outside sales in 
order to take on the Pump Division’s business.  Therefore, applying the transfer pricing formula, 
we get: 
Transfer Price = Variable Cost per unit + incremental costs of the internal order + Lost 
contribution margin per unit on outside sales 
Transfer Price = ($16 ‐$3 savings on internal sales) + $0 = $13 
 
(b) i). Because the Valve Division is selling all that it can produce on the intermediate market, it 
would have to give up some of these outside sales in order to take on the Pump Division’s 
business.  Applying the transfer pricing formula, we get: 
Transfer Price = Variable Cost per unit + incremental costs of the internal order + Lost 
contribution margin per unit on outside sales 
Calculations: 
Variable costs to produce internally:       
$16 variable costs ‐ $3 variable costs    $13 From part a) 
avoided = $13. (from part a) 
     
Incremental costs of internal order    0  
     
Lost CM on external sales:   
Selling price on external sales  30  
VC on external sales  ‐16 $14  
   
    $27  
       
 

Page 5 of 10
 ii)   
 
Cost to buy outside $29 x 10,000 units = $290,000

Cost to make internally:

Variable costs for internal production (16 - 3 ) x 10,000 units $130,000
Lost CM on external sales (30 – 16) x 10,000 units $140,000
$270,000

Net benefit to making internally $ 20,000

 
OR 
Alternate calculation: 
 
For Valve Division 
Revenue from Pump Division ($27 x 10,000)  $ 270,000  
Less: Variable Costs (($16 ‐ $3) x 10,000)  $(130,000) 
Lost Opportunity Cost from selling externally 
10,000 x (30 ‐16)   $(140,000)  
Net Incremental Revenue for Valve Division  $               0 
For Pump Division 
Savings from not buying from outside ($29 x 10,000)  $ 290,000  
Less: Purchase cost paid to Pump Division  $(270,000)  
Net savings to Pump Division  $   20,000  
 
Advantage to Collyer Products, Inc.  $ 20,000 
 
c). Minimum transfer price: 
Variable costs to produce internally       
$13 (from part a, 16‐3) x 10,000    $130,000   
       
Lost CM on external sales:       
Capacity available:       
Maximum  100,000     
Utilized (100,000 x 95%)  95,000     
Available  5,000     
Required  10,000     
Shortfall  (5,000)    
Lose CM on 5,000 units of external sales       
       
5,000 units x $14 (from b i.)    70,000   
    $200,000   
Internal units    ÷ 10,000   
Minimum transfer price per unit    $20.00   
       

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Question #3 (7 marks)

The Penguins play in the North American Ice Hockey League. The Penguins play in the
Downtown Arena, which has a capacity of 30,000 seats (10,000 lower-tier seats and 20,000
upper-tier seats). The Downtown Arena charges the Penguins a per-ticket charge for use of their
facility. All tickets are sold by the Reservation Network, which charges the Penguins a
reservation fee per ticket. The Penguins budgeted net revenue for each type of ticket in 2011 is
computed as follows:
Budgeted Actual Price
Price per per Ticket
Ticket
Lower-tier seats $20 $19
Upper-tier seats $5 $6

The budgeted and actual average attendance figures per game in 2011 season are
Budgeted Actual Seats
Seats Sold Sold
Lower-tier seats 8,000 6,600
Upper-tier seats 12,000 15,400
Total 20,000 22,000

The manager of the Penguins was delighted that actual attendance was 10% above budgeted
attendance per game, especially given the depressed state of the local economy in the past six
months.

Required:

a). Calculate the sales price, sales mix, and sales volume variance. (6.5 marks)

b). Comment on the variance calculated. (.5 marks)

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Solution:
Sales-mix percentages
  Budgeted  Actual 
Lower‐tier  8,000/20,000 = 0.40  6,600/22,000 = 0.30 
Upper‐tier  12,000/20,000 = 0.60  15,400/22,000 = 0.70 

Variances are given below in the table

Page 8 of 10
AP AM AV SP AM AV SP SM AV SP SM BV
19 0.3 22000 $125,400 20 0.3 22000 $132,000 20 0.4 22000 $176,000 20 0.4 20000 $160,000
6 0.7 22000 $ 92,400 5 0.7 22000 $ 77,000 5 0.6 22000 $ 66,000 5 0.6 20000 $ 60,000
$217,800 $209,000 $242,000 $220,000

Price Variance Mix Variance Volume Variance

8800 F -33000 U 22000 F

Total Revenue Variance

-2200 U

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(b) The Penguins increased average attendance by 10% per game. However, there was a
sizable shift from lower-tier seats (budgeted net revenue of $20 per seat) to upper-tier
seats (budgeted net revenue of $5 per seat). The net result: the actual net revenue was
$2,200 below the budgeted net revenue.

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