Problem 22 is confused by the fully allocated financial Peter John Star, owner of The Big Star Hotel, is confused by the fully allocate statements that suggest The Big Star Hotel's lounge is losing money. As he sees it, there are three alternatives: 1. Continue the lounge operation as is. 2. Close the lounge and expand the restaurant. 3. Lease the space to Philip, Inc., a management company. The following table summarizes the Big Star Hotel's fully allocated monthly income statements. Basic Cost Concepts 339 Rooms Restaurant Revenues $250,000 $100,000 Departmental expenses 100,000 70,000 Departmental profit 150,000 30,000 Allocated overhead 100,000 25,000 Pretax income $ 50,000 $ 5,000 Income taxes Net income "All departmental expenses are assumed to be variable. Lounge $40,000 20,000 20,000 30,000 ($10,000) Total $390,000 190,000 200,000 155,000 45,000 20,000 $ 25,000 Additional information: 1. Closing the lounge would reduce monthly overhead costs by $10,000. Leasing the lounge to Philip, Inc., would reduce monthly overhead costs by $5,000. 2. The space can be leased to Philip, Inc., for 10 percent of sales. Philip, Inc. is a reputable operator, and Peter John believes that it will operate the lounge as effectively as The Big Star Hotel has done in the past. Annual forecasted lounge sales are expected to be $550,000 3. If the lounge is closed, room profits are expected to decrease by 2 percent, while food department sales are expected to increase by 20 percent. 4. The cost to convert the lounge for alternative use is expected to be $60,000. Assume that the life of the equipment is five years and that it will have no salvage value. 5. If the lounge is closed, the unneeded equipment can be sold on a contract over five years and $500 will be received each month