A Profit-Maximizing Decision for a Bed & Breakfast
Profit-Maximizing Decision for a Bed & Breakfast
A profit-maximizing decision must be made about whether to keep a bed & breakfast operating. Until the place sells, the mortgage of $3000/month must be paid, since it is a sunk cost. If the restaurant operates, costs rise by $4000 per month, but revenue will be only $6000 per month.
Options for Decision Making
a. It is best to shut down the bed & breakfast since it is taking a loss.
b. It is best to ignore sunk costs and keep the bed & breakfast operating.
c. It is best to shut down the bed & breakfast even though it is making a profit.
d. It is best to keep the bed & breakfast operating because it is profitable.
What is the recommended decision for maximizing profit in this scenario? Answer: b. It is best to ignore sunk costs and keep the bed & breakfast operating. Explanation: The owner of the store will face the mortgage cost whether the bed and breakfast is open or closed, therefore it should be ignored in the short-term for the decision whether or not to keep the business open. The business revenues are $6,000 while their costs are $4,000. This means there is a contribution of $2,000. Then we subtract the mortgage to get a loss of $1,000. If closed, the losses will increase to $3,000 as the mortgage expense would not disappear. We should keep it open and look for ways to either sell or rent the space for a better gain than $2,000.