THE TERMINUS HOTEL

(A)

The Terminus Hotel, a 200-room facility located in a medieval city in Southern

Spain. As consequence of poor management and old-fashioned interior design,
the Hotel experienced slumping demand since 2001. In 2004, the Hotel was on
the brink of bankruptcy. In a sudden1, these dark prospects turned into hopeful
ones; the Hotel was located on a historic building and the regional authorities
approached Mr. Leo D. Marcial, chair of the Chamber of Commerce, to mobilize
local entrepreneurs in order to take over hotel ownership. After some
discussions the entrepreneurs agreed on bidding for the Hotel to make it an
exclusive, high-profile and properly-managed facility. The entrepreneurs
regarded the acquisition of the Terminus Hotel as an opportunity to enter the
hospitality industry under convenient conditions; they could get a first-rate
brand at a relatively cheap price. In January 2007, the new ownership
completed thorough refurbishing of the facility, which comprised new furniture
and state-of-art interior design. The Hotel resumed operations in February 2007
(see Table 1).

Table 1
The Terminus Hotel: Assets (in euros)
(December 31, 2007)

2007 2004
ASSETS
Goodwill 35,000 40,000
Other intangible assets 55,000 25,000
Investment property 9,400 10,000
Property, plant and equipment 6,250,000 2,570,000
Financial assets available for sale 95,000 75,000
Trade and other receivables 90,000 175,000
Deferred tax assets 12,600 90,000
Non-current assets 6,547,000 2,985,000

Inventories 56,000 104,500

Financial assets available for sale 15,000 22,500
Trade and other receivables 875,000 1,150,000
Derivative financial instruments 95,000 117,000
Cash and cash equivalents 1,655,000 2,233,000
Assets held for sale 1,375,000 119,000

Current assets 4,071,000 3,746,000

1
Case prepared by Salvador Carmona and Tashfeen Sohail, IE Business School. Names, figures and dates
are disguised.

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The new Terminus Hotel offered three main services; accommodation,
restaurant and entertainment. The restaurant served haute cuisine designed and
prepared by the team of a world-class chef, whilst entertainment consisted of
flamenco singing and dancing. Restaurant and entertainment services were
open to non-clients.

In their own firms, the entrepreneurs had spare capacity in a number of support
services. In a win-win move, allied firms supplied the Hotel with full service in
areas such as accounting, law, financing, advertising, gardening, receivables
and reservation center. The transfer prices for these transactions were below
market prices (see Table 2).

Table 2
Services provided to the Terminus Hotel by allied firms (in euros)

Service 2007
Law 55,000
Financing 85,000
Accounting 55,000
and Taxation
Advertising 320,000
Gardening 20,000
Reservation 35,000
Center
Receivables 30,000
TOTAL 600,000

Service Profitability Analysis

Although the business plan of the Hotel forecasted losses for 2007, actual results
were below expectations. In order to identify sources of problems, the
entrepreneurs requested a profitability analysis for the three main services
offered by the hotel. Cristina Aranda, the cost analyst of one of the allied firms
and the person in charge of budget and control for the Terminus Hotel, teamed
up with Claudia Santander, General Manager to identify some cost categories
(see Table 3).

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 Table 3
Common costs for accommodation, restaurant and entertainment (euros)

Service 2007
General 55,000
Management
Administrative 15,000
Support
Housekeeping 95,000
Laundry 325,000
Security 100,000
Maintenance 110,000
TOTAL 700,000

Additionally, Cristina calculated the operating profit for each of the main
services offered by the Terminus Hotel (see Table 4).

Table 4
Operating profit for accommodation, restaurant and entertainment services

Accommodation Restaurant Entertainment

Revenues 4,500,000 2,650,000 1,350,000
Operating 4,110,000 2,475,000 1,400,000
Expenses
Operating Profit 390,000 175,000 (50,000)

Furthermore, Cristina and Claudia gathered the following data about each of
the services (see Table 5). This data excludes the support activities shown
above:

Table 5
Data about accommodation, restaurant and entertainment

Accommodation Restaurant Entertainment

Employees 12 16 12
Compensation of € 350,000 € 500,000 € 250,000
employees
Square meters 5,000 m2 200 m2 300 m2
Daily occupancy 75 rooms 40 tables 30 tables
(average)
Property, plant € 5,200,000 €475,000 €325,000
and equipment
(Net of
depreciation)

Drawing on current practices in her firm, a pottery maker, Cristina allocated

100% of common costs to services using number of employees as single cost

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allocation base. In order to generate alternative calculations, Cristina also
prepared an allocation of all common costs using total revenues as single cost
allocation basis.

Both calculations were objected by Claudia. In her opinion, single cost

allocations resulted in simplistic calculations that were unrealistic for decision-
making purposes. As Claudia argued that the complexity of hotel services
could only be captured by using multiple cost allocations, she prepared the
following proposal (Table 6):
Table 6
Allocating common costs by using multiple cost allocation bases

Common cost Cost allocation basis

Financing, Maintenance
Accounting and Taxation,
Reservation center,
Advertising, Law,
General Management,
Admin
Gardening,
Housekeeping, Security
Receivables, Laundry
Value of property,
plant and equipment
Number of employees
Number of square
meters
Revenues

Required assignments:

1. Using Cristina’s single cost allocations, report services profitability.

Explain the rationale behind each of the proposals.
2. Using Claudia’s multiple cost allocation bases, report services
profitability. Comment on the rationale of the proposal.
3. In view of the available information, which decisions would you make?