4. Nehaw Bay Resort w solution-1 PDF

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Nehaw Bay Resort w solution-1...

Description

Prepared by J. Kroeker, 2018 ©

Nehaw Bay Resort Nehaw Bay operates a remote resort in the wilderness. The maximum guestdays of occupancy per month in the resort are 15,000 (500 rooms for 30 days). The guest-days of occupancy and power costs over the past 16 months were: Months Jan 2016 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan 2017 Feb Mar Apr Total

Units 4,002 6,500 8,000 10,500 12,000 9,000 7,500 8,700 5,467 6,789 7,890 4,150 5,300 11,800 12,540 7,634 127,772

Cost 22,125 31,109 37,586 46,003 52,933 50,126 35,487 39,906 28,473 33,325 36,662 23,370 27,498 52,672 54,335 35,686 607,296

a. The CEO has calculated, in a straight-forward, efficient manner, the power cost per guest day to be $4.75. ($607,296 / #127,772) = $4.75 per guest day Evaluate the CEO’s approach. b. Provide a cost formula that would be useful for decision-making for Nehaw Bay Ltd. Estimate the amount of power expense for a month with 11,000 guest days. c. Due to a popular magazine story about the resort Nehaw Bay is expecting 100% occupancy in July 2017. Estimate the power cost for July. d. What does the graph indicate?

Prepared by J. Kroeker, 2018 ©

e. How might planning be impacted if you knew that the electricity was supplied by a small hydro facility?

Answer Key

Nehaw Bay Resort Nehaw Bay operates a remote resort in the wilderness. The maximum guestdays of occupancy per month in the resort are 15,000 (500 rooms for 30 days). The guest-days of occupancy and power costs over the past 16 months were:

Month Jan 2016 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan 2017 Feb Mar Apr Total

Units 4,002 6,500 8,000 10,500 12,000 9,000 7,500 8,700 5,467 6,789 7,890 4,150 5,300 11,800 12,540 7,634 127,772

Cost 22,125 31,109 37,586 46,003 52,933 50,126 35,487 39,906 28,473 33,325 36,662 23,370 27,498 52,672 54,335 35,686 607,296

a) The CEO has calculated, in a straight-forward, efficient manner, the power cost per guest day to be $4.75. ($607,296 / #127,772) = $4.75 per guest day Evaluate the CEO’s approach.

Unitizing fixed costs is dangerous for planning purposes It is quick, but of limited value, the only time the number is useful is when the volume is static and this is rarely the case in business.

Prepared by J. Kroeker. 2018 ©

Nehaw Bay Resort:

Explanation

The CEO’s line is the pink line (average total cost “per unit”). This approach blends the fixed costs into an “average” and is misleading. This will result in the prediction of the cost being overstated or understated depending on the volume predicted. This method has erroneously understated the intercept (zero) and overstated the slope. The danger of using $4.75 is that it oversimplifies the scenario and infers that all costs are variable when the pattern points to the contrary. The blue line is the “high low” line (using two points from the data set) The blue reveals the pattern (variable and fixed) and is thus a better model as it identifies the nature of the underlying cost structure which is partially fixed and partially variable. For decision-making this allows the manager to create a reliable cost estimate at varying levels of occupancy at the resort.

60,000

50,000

Power Costs ($)

40,000

High Low

30,000

CEO

20,000

10,000

-

2,000

4,000

6,000

8,000

Occupancy Days (#)

Prepared by J. Kroeker. 2018 ©

10,000

12,000

14,000

b) Provide a cost formula that would be useful for decision-making for Nehaw Bay Ltd. Estimate the amount of power expense for a month with 11,000 guest days. 54,335 – 22,125 = 32,210 = $3.77 12,540 – 4,002 = 8,538 54,335 – (3.77 x 12,540) = 7,027 Your method Estimates: High Low

Variable

Rise $ Run #

32,210 8,538

Regression R Square Standard Error Observations

Intercept Units

Estimate 11,000 guest days HI Low 11000 CEO 11000 Regression 11000

Fixed

3.77

7,027

3.85

7,204

0.953876 2,346 16

Coefficients 7,203.85 3.85

3.77 4.75 3.85

Standard Error 1,900 0.22

7,027 7,204

48,525.21 52,250.00 49,563.47

The CEO’s method overstates when volume increase and understates when volume is low Estimate 2,000 guest days Hi Low 2000 CEO 2000 2000 Regression

3.77 4.75 3.85

Prepared by J. Kroeker. 2018 ©

7,027 7,204

14,571. 9,500. 14,905.

c) Due to a popular magazine story about the resort Nehaw Bay is expecting 100% occupancy in July 2017. Estimate the power cost for July.

At 100% July has 31 days @ 500 rooms = #15,500 this is significantly above the relevant range of their historical patterns. They could use the estimate from the model but with caution. There could be additional step costs or the variable slope might become steeper. 15,500 x $3.77 + $7,027 =

$64,462

d) What does the graph indicate? Ele c t ric it y c o s t s

60,000

50,000

40,000

30,000

Cost

20,000

10,000

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Unit s

There is a distinct pattern that should not be ignored and this pattern illustrates the presence of a fixed cost (intercept). e) How might planning be impacted if you knew that the electricity was supplied by a small hydro facility? This information would reveal the fact that you can not extrapolate the model very far beyond the current range. We would want to know the capacity of the facility. This would be critical to medium and long term planning decisions. As a hydro facility there is the requirement of water and thus the capacity of the facility is one concern and the other is the supply of water. This creates the need “to qualify” your estimates given these elements that may vary one season to another.

Prepared by J. Kroeker. 2018 ©

Prepared by J. Kroeker. 2018 ©...