COST-VOLUME-PROFIT MODEL:

APPLICATIONS FOR THE STUDY OF

THE FIRM’S OPERATIONS AND
SUPPLY STRATEGY IN THE
TOURISM INDUSTRY
COST-VOLUME-PROFIT MODEL
 3. MIXED COSTS

 Mixed costs: All costs that have a fixed

part and another part that is more or less
proportional to the volume of the activity.

 They are much more frequent than we

may think and mean that it is not so easy
to immediately classify different cost
items as fixed or variable
 3. MIXED COSTS

E.g. hotel operation

 Water and electricity costs have a fixed part that
corresponds to: the minimum costs charged by the utility
company, lighting of common areas and air conditioning
thereof, filling the pool, etc.
 However, there is also a variable part that depends on
the volume of activity; the consumption made by each
guest (in this case the volume of activity may be
measured in terms of stays: one guest one night).
 Remember that the model only admits fixed costs and
variable costs. Therefore, if we encounter mixed costs, we
cannot apply the model unless we find a way of
separating the fixed part from the variable part.
 3. MIXED COSTS

 Remember that the model only admits

fixed costs and variable costs. Therefore,
if we encounter mixed costs, we cannot
apply the model unless we find a way of
separating the fixed part from the
variable part.
 3. MIXED COSTS

 Strictly speaking, the most correct procedure

would consist of analysing each cost individually
and thus determining its variability. However,
this is not always feasible and, it would be very
costly.
 We present three methods:
1. The high-low method (or extreme values)
2. The scatterplot method (or scatter diagram)
3. The regression method
 EXERCISE (1.2)

We have the data for Hotel Mirlo Blanco regarding the behaviour of certain costs
over the last 12 months (see Table 1). Note: stays should be multiplied by 100-
typing error.
 EXERCISE (1.2)

 First of all, it is quite clear that the insurance policy on the property
behaves as a fixed cost, as it remains constant throughout each
month despite fluctuations in level of occupancy. Most typically, this
cost corresponds to a single annual payment which is accrued here,
but either way continues not to depend on the level of occupancy.
 Meanwhile, we have laundry costs and electricity costs. Neither
of these is a fixed cost, but we do not know whether they are
exclusively variable costs, or whether they have a fixed part and are
therefore mixed costs.
 In order to find this out, we can divide the cost by the level of
occupancy for two months with different occupancies. Under the
assumption of proportional variable costs, if the cost is exclusively
variable, we should obtain the same result for each period.
 The unit cost is calculated for periods with a different level of activity.
EXERCISE (1.2)
EXERCISE (1.2)
 HIGH-LOW METHOD (2.1)
 Our exercise consists of estimating the part of the
mixed costs that should be considered fixed and the
part that should be considered variable.
 The electricity costs in our example appear to have a
variable component (as the greater the occupancy, the
larger they are) and a fixed part.
 We have the data regarding the monthly cost throughout
the period under consideration (normally a whole economic
year), but we cannot determine immediately which part is
fixed and which part is variable.
 The high-low method brings about a simplification of the
problem, as it only considers the data of two sub-periods
(two months in our example): the two extreme values.
 HIGH-LOW METHOD (2.1)

 Therefore, assuming that the costs follow a

function of the type y= a+ bx
 We need to find the straight line that passes
through these two points. The intersection with
the vertical axis (which represents the cost) will
be the fixed part (a) and the slope of the line (b)
is the average variable cost (AVC).
 HIGH-LOW METHOD (2.1)
Steps to follow: 

Select the two extreme values as regards volume of activity

1.
(in our example the stays).

 If there is a period of abnormal activity it is better to choose the

next one that does not have this problem (for instance, if the
hotel is closed for a/some month(s), it is desirable to take the
month with the lowest occupancy out of the months it is open).

Calculate the difference between the costs and volume of

2.

activity of these two periods. Then, divide the difference in

costs by the difference in the activity. Thus we obtain the
variable unit cost.
Cperiod of most activity  Cperiod of least activity
AVC 
Qperiod of most activity  Qperiod of least activity
 HIGH-LOW METHOD (2.1)

Steps to follow: 
By multiplying this variable unit cost by the volume
3.

of activity of one of these two periods, we have the

total variable cost for this period, while the rest
corresponds to the fixed cost per period.
4.We multiply the fixed cost per period by the
number of periods considered and this gives us the
fixed part of the mixed cost (for the whole year).
 HIGH-LOW METHOD (2.1)

Let’s apply it to our example:

 HIGH-LOW METHOD (2.1)

Let’s apply it to our example:

SOLUTION (1.2)
 EXERCISE (6.3)
The company Sport Mallorca rents a plot of land, which it uses for sports, for which it
pays an annual rent of €75,000. It has built 8 next generation paddle tennis courts,
some dressing rooms and a social club. The total investment was €500,000 for which
it faces annual amortisation costs of €50,000 and annual costs for financing the
investment of €25,000.
The club is open to the public for a total of 90 hours a week, all the year round. For
2006 we know:

Court rental income 2006 226,000

Court rental hours 2006 11,300

Mixed costs May (maximum 10,400
operation)
Mixed costs December (min. 7,100
operation)
May hours 1,800
December hours 700
The cafe service and the rental and sale of sports goods will be assigned to an
external company which will pay an annual rent of €36,000.
 EXERCISE (6.3)

Please provide as follows:

1. Calculate the break-even point for the company in the annual
number of rental hours and percentage of court occupation.
2. The company’s managers analyse court occupation and discover that
in the mornings (40 of the 90 hours) the club has a lower court
occupation rate. They study the possibility of closing in the mornings and
forecast that if they do this they could partially reduce fixed costs,
specifically €25,000 per annum. If they close in the mornings the
contract assigning the café would be amended by €10,000 less per
annum. With this data, please answer the following:
a)What would the minimum court occupation rate in the mornings be
that would compensate having the club open?
b)In the case that it is decided to close in the mornings, what will the
new break-even point be?
SOLUTION (6.3)
SOLUTION (6.3)
SOLUTION (6.3)- 2
 EXERCISE (6.3)

3. The company proposes an alternative working for the Paddle Tennis

Club business which is as follows:
 The courts will not be rented to the public, entry to the club will be
restricted to members who will pay an annual membership fee. The
social club will be open for 90 hours a week and will have a series
of additional services for its members, such as child minding and a
towel service, which are calculated to involve additional fixed
annual costs of some €55,000 (all other entries for fixed costs in
paragraph 1 remain). To calculate the variable costs, it is
estimated that the variable cost per member for water and
electricity consumption and other variable costs will be
€250/member per annum.

 Calculate the number of members that the club needs to reach

break-even point, with the knowledge that each member will pay
membership fee of €750 per annum.
SOLUTION (6.3)- 3