IB Business Management HL 5.5.4 Limitations of Break Even Topic Practice

Icarus


Icarus is an adventure tourism company. It has developed a family brand of innovative tourism products, such as the World's first underwater theme park. Its next objective is to build the first hotel in outer space by 2016. Icarus conducted market research using stratified samples of businessmen/businesswomen and families with incomes over $\$10000000$. Most said that they would pay the proposed price of $\$140000$ per room per night. Although the hotel should create significant profits, Icarus' Board of Directors is concerned about both safety and financial risks.

Icarus has invested significant funds to develop safety procedures and to train the employees of the future hotel. Icarus wants to protect its brand image as the most trusted adventure tourism company in the world.

The hotel will have a capacity of 500 rooms. Originally (in 2012) Icarus forecasted the following (in $):
- price per room per night (room rate): 140000
- fixed costs: 10000000
- variable cost per room per night: 100000 .

Now (in 2013) the costs of construction, fuel and insurance have increased and affected the forecast. To ensure a 2016 opening, Icarus has identified a potential investor. The problem is that he expects a $\$2000000$ guaranteed (target) profit in the first year, but Icarus has promised not to increase its room prices. The following shows the revised forecasted figures (in $):
- price per room per night (room rate): 140000
- target profit required by investor: 2000000
- fixed costs: 12000000
- variable cost per room per night: 108000 .

The Board of Directors are concerned that:
- keeping room prices the same will reduce profits
- other adventure tourism companies are considering entering the outer space tourism market
- withdrawing from the project would damage Icarus' brand image and would cost millions of dollars.

Explain the limitations of the 2013 break-even chart from part (i) as a decision-making tool for Icarus.