A catering service has been asked to provide a lunch buffet the next day for 40 people at a set price of $10.50 per person; no function has been booked for the next two days. The catering service has fixed costs of $150 a day, or $54,750 per operating year, and it operates with a variable cost of 65% of sales revenue. Calculate the operating income from the function and justify your decision to accept or not accept the booking.

The answer is :

Operating income: -($3); accept the booking

Explanation:

The decision to accept or reject the booking depends on the capacity of the catering business, the profit derived from accepting the booking and the additional business that could be generated as a result of the booking. Operating income is the gross income less operating expenses. By accepting the booking the catering service contributes $147 towards covering the fixed costs. The calculations below depict the difference in contribution when the booking is accepted and when the booking is not accepted.

Booking (No other booking for the next two days)

No Booking = No revenue, unused capacity

Fixed costs total: $54, 750 per year

Lunch buffet booking:

Number of people: 40

Price per person: $10.50

Fixed costs per day: $150

Variable cost : $6.825 (0.65 * $10.50)

If order is accepted:

Contribution to fixed costs for the day: $3.675

Operating income= (Sales revenue - Variable Costs) - Fixed  Costs

                              = ($10.50 - $6.825)*40) - $150

                              = $147 - $150

                              = -($3)

If order is NOT accepted:

Contribution to fixed costs for the day: $0

Operating income= (Sales revenue - Variable Costs) - Fixed  Costs

                              = $0- $150

                              = -($150)

                              = -($150)

Since there are no other bookings for the next two days, the business does have the capacity for the booking, a positive contribution of $147 to fixed costs and possibly repeat business generated as a result of taking on the booking leading to higher future cash flows.

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