Cost-plus target return on investment pricing. John Blodgett is the managing partner of a business that has just finished building a 60-room motel. Blodgett anticipates that he will rent these rooms for 15,000 nights next year (or 15,000 room-nights). All rooms are similar and will rent for the same price. Blodgett estimates the following operating costs for next year:
Variable operating costs…………………………….$5 per room-night
Fixed costs
Salaries and wages……………………………………………$173,000
Maintenance of building and pool………………………………52,000
Other operating and administration costs……………………...150,000
Total fixed costs………………………………………………$375,000
The capital invested in the motel is $900,000. The partnership’s target return on investment is 25%. Blodgett expects demand for rooms to be uniform throughout the year. He plans to price the rooms at full cost plus a markup on full cost to earn the target return on investment. For simplicity, ignore the time value of money.
Required
1. What price should Blodgett charge for a room-night? What is the markup as a percentage of the full cost of a room-night?
2. Blodgett’s market research indicates that if the price of a room-night determined in requirement 1 is reduced by 10%, the expected number of room-nights Blodgett could rent would increase by 10%.
Should Blodgett reduce prices by 10%? Show your calculations.