1. What is the minimum number of passengers Health Cruises must sign up by November 20th to break even?
Considering that an average ticket price is $1500 and the cost per passenger is $200, each sold ticket generates $1,300 of the positive cash flow. Since $295,000 of the initial capital had been spent by November 14th, the following minimum number of passengers must sign up in order for Health Cruises to break even provided no more money is invested:
Minimum passengers to break even = $295,000 / $1,300 = 227.
2. Should Health Cruises go ahead with the cruise since 200 people have signed up by November 14th? Why or why not?
Health Cruises should go ahead with the cruise in any event. If the cruise is canceled, $295,000 of the already spent capital would become a total loss. Even if no more passengers sign up, the loss would be only $35,000, i.e. (200 * $1,300) – $295,000.
3. The advertising agency has proposed two alternative campaigns to help fill the boat. One will cost $6000 and the other would cost $15,000. Which would you suggest?.
If 20 additional passengers sign up and pay on average $1,500 as expected with the limited advertising campaign which cost $6,000, the net earnings (loss) of the cruise will be as followed:
EBIT = (220 * $1,300) – ($295,000 + $6,000) = -$15,000. (A loss of $15,000)
If 40 additional passengers sign up and pay on average $1,500 as expected with the more ambitious advertising campaign, the net earnings of the cruise will be as followed:
EBIT = (240 * $1300) – ($295,000 + $15,000) = $15,500. (A profit of $15,500)
To summarize, the ambitious advertising campaign is more beneficial for the Health Cruises’ bottom line than the limited advertising campaign.
4. Should Health Cruises consider cutting its prices for this trip? Why or why not? What other factors could impact the go/no-go decision in addition to the break even?
Since even with the ambitious advertising complain there is a distinct possibility that the cruise will be short of its full capacity by 60 passengers, the cutting cruise prices may provide an increase in the profit beyond expected $15,500 (with the ambitious advertising campaign) due to more ticket sold.
Assuming that it is possible to sign up additional 100 passengers if the ambitious advertising campaign also offers reduced ticket prices, we can calculate that the minimum average ticket price that that passengers should pay and still provide for the $15,500 profit:
MinTicketPrice = ($35,000 + $15,000 + $15,500) / 100 + $200 = $855, where $35,000 is loss as November 14th, $15,000 is the advertising campaign cost, $15,500 is the minimum profit, and $200 is cost per passenger.
Ideally the cruise profit could be maximized by adjusting the ticket price in response to demand and supply. However, even if additional tickets are offered outright at an average price of $1,200 (a 20% discount) in order to generate enough demand to sell the remaining 100 tickets the cruise earnings can be calculated as follow:
EBIT = (200 * $1300) + (100 * $1000) – ($295,000 + $15,000) = $50,000.
Note that $200 cost for passenger is deducted from ticket prices in the above calculation.
The only risk with such a price reduction is that the reduced price would not be able to generate enough demand to sell all remaining 100 tickets. However, the cruise still would break even if 50 tickets are sold at an average price of $1,200 and the cruise profit would exceed the target $15,500 if more than 65 tickets are sold at this reduced price.
A 20% price reduction is just an example to drive the point. The Health Cruises management may have some marketing data to help to come with a more appropriate number.
It does not appear that there are any factors (even the break even should not be a factor with 200 tickets sold and $295,000 spent) other than a bad business practice that could impact the go/no-go decision. Health Cruises, Inc.
Health Cruises, Inc. packages cruises to Caribbean islands such as Martinique and the Bahamas. Like conventional cruises, the packages are designed to be fun. But the cruise is structured to help participants become healthier by breaking old habits, such as smoking and overeating. The Miami-based firm was conceived by Susan Isom, 30, a self-styled innovator and entrepreneur. Prior to this venture, she had spent several years in North Carolina promoting a behavior-modification clinic.
Isom determined that many people were very concerned about developing good health habits, yet they seemed unable to break away from their old habits because of the pressures of day-to-day living. She reasoned that they might have a chance for much greater success in a pleasant and socially supportive environment, where good health habits were fostered.
Accordingly, she established Health Cruises, Inc., hired 10 consulting psychologists and health specialists to develop a program, and chartered a ship. DeForrest Young, a Miami management consultant, became the chairperson of Health Cruises. Seven of Isom’s business associates contributed an initial capital outlay totaling more than $250,000. Of this amount, $65,000 went for the initial advertising budget, $10,000 for other administrative expenses, and $220,000 for the ship rental and crew.
Mary Porter, an overweight Denver schoolteacher, has signed up to sail on a two-week cruise to Nassau, departing December 19. She and her shipmates will pay an average of $1,500 for the voyage. The most desirable staterooms cost $2,200. Mary learned of the cruise by reading the travel section of her Sunday newspaper on October 16. On that date, the Pittsford and LaRue Advertising Agency placed promotional notices for the cruise in several major metropolitan newspapers. Mary was fascinated by the idea of combining therapy sessions with swimming, movies, and an elegant atmosphere.
Pittsford and LaRue account executive Carolyn Sukhan originally estimated that 300 people would sign up for the cruise after reading the October 16 ads, but as of November 14 only 200 had done so. Isom and Health Cruises, Inc. faced an important decision. “Here’s the situation as I see,” explained a disturbed Ms. Isom at the Health Cruises board meeting. “We’ve already paid out more than a quarter of a million to get this cruise rolling. It’s going to cost us roughly $200 per passenger for the two weeks, mostly for food.
Pittsford and LaRue predicted that 300 people would respond to the advertising campaign, but we’ve only got 200. I see three basic options: (1) we cancel the cruise and take our losses; (2) we run the cruise with the 200 and a few more that will trickle in over the next month, or (3) we shell some more money and hope that we will pull in more people. My recommendation to the board is that we try to recruit more passengers. There are simply too many empty rooms on that ship. Each one costs us a bundle.”
At this point, Carolyn Sukhan addressed the board: “I’ve worked out two possible advertising campaigns for the November 20 papers. The first, the limited campaign, will cost $6,000. I estimate that it will bring in some 20 passengers. The more ambitious campaign, which I personally recommend, would cost $15,000.
I believe this campaign will bring in a minimum of 40 passengers. I realize our first attempt was somewhat disappointing, but we’re dealing here with a new concept, and a follow-up ad might work with many newspaper readers who were curious and interested when they read our first notice.”
“One thing is absolutely certain,” Sukhan emphasized. “We must act immediately if there’s any hope of getting more people on board. The deadline for the Sunday papers is in less than 48 hours. If our ads don’t appear by this weekend, you can forget it. No one signs up in early December for a December 18 sailing date.”
Isom interrupted, shaking her head. “I just don’t know what to say. I’ve looked over Carolyn’s proposals and they’re excellent, absolutely first-rate. But our one problem, to be blunt, is money. Our funds are tight and our investors are already nervous. I get more calls each day, asking me where the 300 passengers are. It won’t be easy to squeeze another $6,000 out of these people. And to ask them for $15,000 – well, I just don’t know how we’re going to be able to justify it.”