This document is authorized for use only in IE University. THE TERMINUS HOTEL (A) Original written by Professors Salvador Carmona and Tashfeen Sohail at IE Business School. Original version, April 12, 2011. Last revised June 26, 2017. (L.R) Published by IE Business Publishing, Mara de Molina 13, 28006 - Madrid, Spain. 2011 IE. Total or partial publication of this document without the express, written consent of IE is prohibited. CG1-130-A-I 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. All of a sudden, these dark prospects turned into hopeful ones; the hotel was located in 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-the-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 Other intangible assets Investment property Property, plant and equipment Financial assets available for sale Trade and other receivables Deferred tax assets 35,000 40,000 55,000 25,000 9,400 10,000 6,250,000 2,570,000 95,000 75,000 90,000 175,000 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 Este documento es autorizado para uso exclusivo de IE University. This document is authorized for use only in IE University. IE Business School THE TERMINUS HOTEL (A) CG1-130-A-I The new Terminus Hotel offered three main services: accommodation, a 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 the 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 55,000 Law Financing 85,000 Accounting and Taxation Advertising 55,000 320,000 Gardening 20,000 Reservation Center 35,000 Receivables TOTAL 30,000 600,000 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 General Manager Claudia Santander to identify some cost categories (see Table 3). TABLE 3 COMMON COSTS FOR ACCOMMODATION, RESTAURANT AND ENTERTAINMENT (EUROS) Service General Management Administrative Support Housekeeping Laundry Security Maintenance TOTAL 2007 55,000 15,000 95,000 325,000 100,000 110,000 700,000 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 Revenues Operating Expenses Accommodation 4,500,000 4,110,000 2 Restaurant 2,650,000 2,475,000 Entertainment 1,350,000 1,400,000 Este documento es autorizado para uso exclusivo de IE University. This document is authorized for use only in IE University. IE Business School THE TERMINUS HOTEL (A) Operating Profit 390,000 175,000 CG1-130-A-I (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: Employees TABLE 5 DATA ABOUT ACCOMMODATION, RESTAURANT AND ENTERTAINMENT Accommodation 12 Restaurant Entertainment Compensation of employees Square meters Daily occupancy (average) Property, plant and equipment (Net of depreciation) 16 500,000 200 m2 12 250,000 300 m2 30 tables 350,000 5,000 m2 75 rooms 40 tables 5,200,000 475,000 325,000 Drawing on current practices in her firm, a pottery, Cristina allocated 100% of common costs to services using a number of employees as single cost 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. Claudia objected to both calculations. 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 Financing, Maintenance Accounting and Taxation, Reservation Center, Advertising, Law, General Management, Admin. Cost allocation basis Value of property, plant and equipment Number of employees Gardening, Housekeeping, Security Receivables, Laundry 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? Este documento es autorizado para uso exclusivo de IE University.