Cost Volume Profit Analysis: Garnet Hotels Budget Hotel Proposal

The assignment presents a Cost Volume Profit (CVP) analysis for Garnet Hotels, focusing on the potential expansion with a new budget hotel in London. The analysis considers various costs, including variable costs per room, maintenance, and overheads, to determine the optimal pricing strategy and break-even point. The report calculates the number of occupied rooms, estimates total yearly costs, and evaluates different pricing scenarios to achieve the target profit. It highlights the importance of competitive pricing and occupancy rates, comparing the proposed pricing with competitor offerings. The analysis suggests a price range to maintain competitiveness and profitability, along with the limitations of the CVP analysis, such as dependence on occupancy rates and competitor strategies. The report recommends setting prices between £150 and £175 per night and providing discounts to increase occupancy and profit. The report concludes by emphasizing the need for careful consideration of pricing and market dynamics to ensure the success of the new hotel venture.

Introduction:
Cost Volume Profit (CVP) analysis is the method of costing which takes into account the impact
of the changing level of the cost and volume which will generate operating profit. It is also
termed as the break-even analysis and it determines the break-even point for various sales
volume and cost structure that is used by the management in taking short term decisions related
to entity economic condition. This analysis considers various assumptions such as sales price;
fixed costs and variable cost per unit are same (Etges, et al 2016).
The cost volume profit (CVP) analysis is used by the management to determine the sales volume
required to cover the costs and break-even and the management determines the target sales
volume of the entity. The management uses contribution margin for calculating the break-even
point of sales and profit is added to the fixed costs to perform CVP analysis on the targeted
income. The CVP analysis is only reliable when the costs are fixed within the specified
production level. In this analysis all units produced are presumed to be sold and all the fixed
costs should be constant in the cost volume profit analysis (Will Kenton 2019). This also
includes another presumption that the change in the expenses result due to the variation in the
activity level. Further the semi variable expenses should be allocated among the classification of
expenses considering the high-low method or scatter plot (Alnasser, et al 2014).
The CVP analysis also balances the contribution margin of the product and it is the difference
between the total sales and total variable costs of the product. Thus when the management wants
business to be profit generating business then the contribution margin should be more than the
total fixed costs (Kee, R. 2007).

Analysis of the given case:
Similarly in the given case the hotel management wants to open the new budget hotel and
estimates the costs such as variable costs per overnight stay in room as £ 12.50 and also
estimates the monthly maintenance and cleaning costs as £6,500 and other annual overheads at
£3,134,000 and the average annual occupancy rate will be 80% only when the hotel will charge
the competitive rates. Thus management has used the cost volume profit (CVP) analysis to
determine the pricing strategies and the profitability of the hotel so that the group profit can be
enhanced (Woodruff, Jim.2019). Thus the management has to first estimate the number of rooms
which are going to be occupied in a year on an average occupancy rate of 80% which is as
discussed below:
Particulars Value
No. of Rooms 80
No. of days in a year 365
Room days in a year 29200
Occupancy 80%
Occupancy room days in year 23360
From the above analysis it is evident that the 23,360 rooms will be occupied in a year on an
average basis and accordingly the management has to determine the pricing policy so as to
compete with its competitors. Thus on the basis of the estimated variable and fixed costs the

management will determine the target price to achieve the target profit of £760,000 which is as
discussed below:
Particulars Amount(£)
Yearly variable cost 292000
Yearly maintenance and cleaning costs 78000
Other annual overheads 3134000
Total yearly cost 3504000
Target profit 760000
Revenue 4264000
Target price (Total revenue/ Occupancy of room days in
a year) 183
From the above cost volume profit analysis (CVP) it is evident that to achieve the target profit of
£760,000 the hotel management should keep the price of £183 per night as the occupancy rate
but at this price the hotel will not retain as many customers as they are expecting because the
competitor of this hotel entity is offering the same service at £175 per night. Further this pricing
policy will not attract and retain the customers as the competitor is offering same service at
cheaper price (Katsanos, Kelley). Thus it is advisable that the management should first consider
another pricing policy which will provide long term benefit to the entity and the entity will be
able to compete in the market. Therefore the management should determine the alternative prices
for the entity so that they would estimate the point at which the entity will be able to cover all its
cost (Manes, R). Thus the management should determine the minimum price as below:

Particulars Amount
Total yearly cost (Including variable and other relevant costs) 3,504,000
Occupancy room days in a year 23,360
Minimum price per room day per room to be charged (3,504,000/
23,360)
150
If the entity is charging 150 per room per day then it is expected that the entity will be at no
profit no loss and will be able to cover all costs from new venture. If the company charges 183
per room per night to achieve target profitability then there are chances that the entity won’t be
able to achieve 80% average occupancy and can lose its customers due to tough competition. A
nearby competitor hotel is charging only 175 per night for same facilities whereas for Garnet
hotels price is 183. Garnet hotel is at break- even level if charging 150 per room per night. To
maintain tough competition, the hotel should decide leverage price policy and the prices can be
fixed in the range between 150-175 per room per night. By setting the price range the entity will
neither incur loss nor it will lose its customers because the entity is charging the price similar to
competitor hotel. If the company keeps price 175 then still it can earn profitability of 584,000 in
a year.
The entity can also provide the discount to its customers so that occupancy rate can be increased
and the entity can achieve its objective of higher and increased profitability (Ellram, Lisa). The
entity can set the price per room per night in the ranging between 150 to 175 and can provide the
discount by keeping the target of minimum price 150 per room per night. The main limitation of

this analysis is that it is based on the occupancy rate and rate is not fixed as it is based on the
pricing policy of the entity and its competitors. Further the analysis is not accurate as the
decision of the management is dependent on the occupancy of the rooms and occupancy of the
rooms is dependent on the pricing strategy of the competitors.
References:
Etges, Ana Paula & Calegari, Rafael & Dos Santos Rhoden, Marisa Ignez & Cortimiglia,
Marcelo. (2016). USING COST-VOLUME-PROFIT TO ANALYSE THE VIABILITY OF
IMPLEMENTING A NEW DISTRIBUTION CENTER. Brazilian Journal of Operations &
Production Management. 1. 44. 10.14488/BJOPM.2016.v13.n1.a4.
Will Kenton (2019). Cost Volume Analysis-CVP Analysis. Available at
https://www.investopedia.com/terms/c/cost-volume-profit-analysis.asp
Kee, R. (2007). Cost-Volume-Profit Analysis Incorporating the Cost of Capital. Journal of
Managerial Issues, 19(4), 478-493. Available at www.jstor.org/stable/40604583
Alnasser, Dr & Shaban, Osama & Al-Zubi, Ziad. (2014). The Effect of Using Break-Even-Point
in Planning, Controlling, and Decision Making in the Industrial Jordanian Companies.
International Journal of Academic Research in Business and Social Sciences. 4.
10.6007/IJARBSS/v4-i5/888.

Manes, R. (n.d). A New Dimension to Breakeven Analysis. Journal of Accounting
Research, 4(1), 87-100. doi:10.2307/2490143
Ellram, Lisa. (n.d.). Total Cost of Ownership: An Analysis Approach for Purchasing.
International Journal of Physical Distribution & Logistics Management. 25. 4-23.
10.1108/09600039510099928.
Woodruff, Jim. (2019, December 12). The Benefits of Analyzing Cost-Volume-Profit.
bizfluent.com. Retrieved from https://bizfluent.com/info-8428943-benefits-analyzing-
costvolumeprofit.html
Katsanos, Kelley. (n.d.). Introduction to a Cost Analysis Report. Small Business - Chron.com.
Retrieved from http://smallbusiness.chron.com/introduction-cost-analysis-report-81459.html