Question

Pacific Cruises provides standard riverboat cruises for tourists on the Hawkesbury River. The average cruise has 90 passengers on board. Each passenger pays $100 for a day’s cruising. The riverboat cruises 120 days each year in meeting current demand. There are 14 crew who are each paid an average of $130 per cruise. The crew is paid only when the boat sails. Other variable costs are for refreshments, which average $20 per passenger per cruise, and fuel which averages $400 per cruise. Total annual fixed costs are $380,000.

REQUIRED

(a) Calculate revenue and variable costs for each cruise.

(b) Calculate the number of cruises needed annually to break even.

(c) Using the contribution margin approach calculate the number of cruises needed to annually earn $500,000 profit over breakeven. Discuss whether this profit goal is realistic under current conditions and possible assumptions and limitations of the “cost / volume / profit model” at such higher volume levels. (word limit 60)

(d) Pacific Cruises is considering replacing the existing one-day cruises as detailed above with a one-day luxury cruise costing more at $180 per passenger. Under this new proposal it is estimated that demand will increase, requiring the boat to cruise for 150 days each year with each cruise taking 50 passengers. Other costs to change from the original offer include refreshments, up from $20 to $30 per passenger, and annual fixed costs to increase from $380,000 to $450,000. All other variable costs remain the same per passenger as per the standard cruise offer.

(i) Calculate the number of cruises needed annually to break even.

(ii) Given Pacific Cruises wants to maximize total yearly profit discuss, justifying your answer, whether they should continue with the existing standard cruise or replace it with the luxury cruise. Comment on the level of risk of each proposal and the possibility of making a loss. (Please note the boat has the same useful life / residual value under either the standard or luxury offer. The boat remains docked at the harbour when not in use having no alternate use.) Show all workings/ calculations as part of your answer. (limit 80 words)

(e)Explain to Pacific Cruises’ management how they would be able to integrate cost-volume-profit analysis into their broader planning. As part of your answer, discuss three ways to increase profit and explain how cost volume profit analysis is useful in evaluating the different alternatives considered. (150 words limit)

Answer 1

a

Calculate revenue and variable costs for each cruise.

Revenue

90*$100

$9,000

Variable Cost

Crew Wages

14*$130

1820

Cost of Refreshments

90*$20

1800

Cost of Fuel

400

Total Variable Cost

4020

b

Calculate the number of cruises needed annually to break even.

Revenue

9000

Variable Cost

4020

Contribution per Cruise

4980

Annual Fixed Costs

$380,000

Break Even units

Fixed Cost/CM per cruise

380000/4980

76.3

76 cruises

c

Using the contribution margin approach calculate the number of cruises needed to annually earn $500,000 profit over breakeven

Annual cruises of target profit

380000+500000/4980

176.7

177 cruises

Discuss whether this profit goal is realistic under current conditions and possible assumptions and limitations of the “cost / volume / profit model” at such higher volume levels

*With the increase in capacity the fixed cost also increase from the current capacity level.

* This profit goal is not realistic on the grounds that the costs on which the profit is calcuated may be uncertain and likely to increase

*The no of passengers taking board the cruise may not be certain all the times so the contribution margin is also uncertain.

d(i)

Calculate the number of cruises needed annually to break even.

Calculation of Revenue and variable cost

Revenue

50*$180

9000

Variable Cost

Crew Wages

14*$130

1820

Cost of Refreshments

50*$30

1500

Cost of Fuel

400

Total Variable Cost

3720

Contribution per Cruise

5280

Annual Fixed Costs

450000

Break Even units

Fixed Cost/Contribution Margin per cruise

450000/5280

85.22

85 cruise

ii)

Given Pacific Cruises wants to maximize total yearly profit discuss, justifying your answer, whether they should continue with the existing standard cruise or replace it with the luxury cruise

Analysis of the existing and Luxury cruise

Std

Luxury

Differential

Contribution per Cruise

4980

5280

300

No of days of one day cruise

120

150

30

Total Contribution

597600

792000

194400

Less Fixed Costs

380000

450000

70000

Net Profit

217600

342000

124400

Break Even units

76

85

So by analyzing the situation it is seen that the differential profit from implementing the luxury cruise Is worthwhile on the grounds as discussed below:

* the demand for the cruise days should be predicted correctly as the price is double in case of luxury.

*The cost of variable cost of refreshments also increase by $10 per passenger