Rollins and Associates develops hotels in resort locations. The company is exploring the construction of a new facility that would have significant meeting and banquet space for conventions and conferences, and sleeping rooms that average 850 square feet. The accounting department estimates that land and building costs will amount to $60 and $120 per square foot of floor area, respectively. Other expenditures during construction for interest, real estate taxes, and general overhead are expected to total 35% of land and construction cost. Once basic construction is completed, Rollins anticipates per-room initial expenditures for:Sleeping room furnishings and accessories$16,000Supplies1,900Marketing5,500The accounting department suggests that 10% be added to the total of all preceding
costs to allow for estimation errors. Construction is anticipated to take two years.Rollins' pricing policy is consistent with that of industry leaders, namely, to set a room rate equal to .1% (.001) of cost. Upon completion, comparable facilities are expected to charge $240 per day.Required:A. Compute the total cost of a sleeping room at the new facility.B. Is the company's room rate competitive? Briefly explain.C. Rollins desires to enter this market by adhering to the industry standard and charging a competitive room rate. If needed, the firm will look for ways to cut expenditures. Briefly explain the difference between cost-plus pricing and target costing.D. Other than operating costs and room revenues, what else should Rollins consider before a final decision is made about the facility?
What will be an ideal response?
A.
| Land: 850 square feet × $60 | $51,000 |
| Construction: 850 sq. ft. × $120 | 102,000 |
| Subtotal | $153,000 |
| Interest, taxes, and overhead: $153,000 × 35% | 53,550 |
| Furnishings and accessories | 16,000 |
| Supplies | 1,900 |
| Marketing | 5,500 |
| Subtotal | $229,950 |
| Estimation errors: $229,950 × 10% | 22,995 |
| Total | $252,945 |
B. The rate may or may not be competitive, depending on whether the estimation errors materialize. The going market rate is $240 per day, while Rollins' rate will range between $229.95 and $252.95.
C. With target costing, a firm first determines a competitive market price to charge for its good or service and then subtracts an appropriate profit margin. The result is a targeted cost figure, which may require that a process be redesigned through an approach known as value engineering. In contrast, cost-plus pricing begins with a company's costs and adds a markup to arrive at the selling price.
D. The facility is being designed to accommodate conferences and conventions, meaning that significant added revenues and income may result. For example, audio-visual rentals and large-scale dining and liquor sales commonly arise from such events. Furthermore, many things can change during the two-year construction period (e.g., economic downturns and new competitors) that could alter the company's analysis and construction decisions.
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