You are founder of a new Boston-based company, London Inc. The Company will provide luxury tours in the United Kingdom. The Company has its headquarters in Boston and is considering it operating structure in the UK. The alternatives being considered include:
1) Contract with independent contractor that will operate the tours in the UK
2) Establish an operations center in the UK to run the tours by Company personnel The management team has developed the following information for you to consider:
• Although demand is uncertain, it is expected to be for 10 passengers on each of the 150 tours being offered for the 2016; sales growth is expected to be 50% in 2017 and 70% in 2018; continued, although more moderate growth is expected in years thereafter
• Tour price is $2,500 per person excluding airfare which passengers are responsible for obtaining on their own
• Fixed costs of the Company’s Boston headquarters for the coming year is estimated at $1,000,000
• Tours will be sold through travel agents who are paid a 10% commission
• The independent contractor would charge a $100,000 annual fixed payment along with a per passenger fee of $1,750
• The annual cost to run an operations center in the UK would be $1,000,000 and the per passenger cost to run the tours would be $1,500
• The maximum capacity under alternatives 1 & 2 is 10,000 passengers
(A) What would be the breakeven level of activity in terms of number of passengers for each of the 2 alternatives being considered (e.g., contract with an independent contractor to run the tour or establish an operations center in the UK to run the tours by Company personnel)?
(B) What alternative would you choose if you are seeking the alternative:
a. Encompassing lower risk? (explain your answer)
b. Higher earnings in 2018 and thereafter? (explain your answer)
c. What is the key factor that should drive the decision when considering alternative 1 versus 2?