Question 4: Cost allocation[25 points]

EatFlyGulf (EFG) provides passenger meals to airlines operating from DXB.They charge an airline AED70 per meal and assume the following costs:

Direct variable cost of a meal:AED 30

Overhead cost allocated to a meal:AED 20

In the average week, EFG will serve approximately 50,000 meals, and the above figures are based on this volume.

a)How much overhead does EFG incur in an average week?

In reviewing performance data, the CFO noted the following for three clients:

Menu options Number of meals Number of flights

Air Haydn185,00010

LBS Airlines410,00070

EMBA Express108,00030

b)Based on the above information, determine the revenue, profit and profit margin (%) EFG enjoys from the three airline customers mentioned

As the CFO sat in her plush office, the image of a man floated through her mind.She wondered who it was... and then it came to her."Sutton, Willie Sutton!Go where the money is, often!" she recalled from her EMBA.The she tasked up her analyst and, a day later, he reported the following:

I looked into overheads and discovered they all fall into one of four buckets.

Kitchen cost (rent, electricity etc) accounts for 20% of overhead and I think this is best allocated based on meals prepared

Airport transfer cost (the cost of getting the meals from our kitchen to the plane at the terminal) is about 40% of overhead and I discovered it costs about the same to service a large aircraft with lots of meals, as it does to service a small aircraft with only a few meals.In the average week we service 550 flights

As you know, we offer airlines unique menu items - so if we serve a particular dish to one airline, we will not offer that same menu item to any other airline.I checked with our Head Chef... at the moment we're offering 50 different menu options.This accounts for about 30% of overheads and is mostly menu design and procurement cost

The rest of the overhead?Well, it's customer service or account management and I think it's best spread evenly over our 7 clients

c)Apply Activity Based Costing to determine allocation rates for each bucket

d)Using the revenue amounts from (b) and the ABC rates you calculated in (c), determine the profit (AED) and profit margin (%) EFG enjoys from each of the airline customers mentioned

e)What are the insights from this ABC analysis?What might it mean for pricing?