SAPKALE LALIT

PGP/1348/06

CASE 16-1: HOSPITAL SUPPLY

1. What is the break-even volume in units? In sales dollars?
A. Break-even Sales in Units
= Total Fixed Costs / Unit Contribution Margin
= (660 + 770) * 3,000/(4,350 - 2,070)
=1,882 units

B. Break-even Sales in Dollar

=Total Fixed Costs / Contribution Margin Ratio
= (660 + 770) * 3,000/((4,350-2,070)/4,350)
=$8,185,461
2. Market research estimates that monthly volume could increase to 3,500 units, which is well
within hoist production capacity limitations, if the price were cut from $4,350 to $3,850 per unit.
Assuming the cost behaviour patterns implied by the data in Exhibit 1 are correct, would you
recommend that this action be taken? What would be the impact on monthly sales, costs, and
income?

It would only take 1,882 units to break even in the old estimate whereas 2,812 units in the new
estimate. It means they need to produce more units just to recover all the costs they incurred. In
addition, reducing the selling price means a clear reduction in net profits. Kindly see below table
for the effects on sales, costs, and income.
Old Estimate New Estimate Net Effect
Price 4,350 3,850 (500)
Quantity 3,000 3,500 500
Total Sales $13,050,000 $13,475,000 $(250,000)
Variable costs $1,650,000 $1,925,000 $275,000
Materials 550 2,475,000 2,887,500 412,500
Labor 825 1,260,000 1,470,000 210,000
Overhead 420 825,000 962,500 137,500
Variable 275
Marketing
Total Variable 6,210,000 7,245,000 1,035,000
Contribution 6,840,000 6,230,000 (610,000)
Margin
Fixed Costs
Overhead 660 1,980,000 1,980,000
Fixed 770 2,310,000 2,310,000
Manufacturing
Total Fixed 4,290,000 4,290,000
Costs
Income $2,550,000 $1,940,000 $(610,000)
SAPKALE LALIT
PGP/1348/06

3. On March 1, a contract offer is made to Hospital Supply by the federal government to supply
500 units to Veterans Administration hospitals for delivery by March 31. Because of an unusually
large number of rush orders from its regular customers, Hospital Supply plans to produce 4,000
units during March, which will use all available capacity. If the government order is accepted, 500
units normally sold to regular customers would be lost to a competitor. The contract given by the
government would reimburse the government's share of March production costs, plus pay a fixed
fee (profit) of $275,000. (There would be no variable marketing costs incurred on the government's
units.) What impact would accepting the government contract have on March income?
The consequence of accepting the government contract would result to lesser sales from Hospital
Supply since it would incur more profit if they continue to hold on to the existing customers. The
recommendation for this is “do not accept.”

Share of contribution margin from $1,140,000

original customers
(500*2280)
New contract from government
Fixed payment from government $275,000
Share of fixed costs-manufacturing 247,500
(500/4,000)*1,980,000
Should have been income from 522,500
government contract
Difference in profit from 2 alternatives $(617,500)

4. Hospital Supply has an opportunity to enter a foreign market in which price competition is keen.
An attraction of the foreign market is that demand there is greatest when demand in the domestic
market is quite low; thus, idle production facilities could be used without affecting domestic
business. An order for 1,000 units is being sought at a below-normal price in order to enter this
market. Shipping costs for this order will amount to $410 per unit, while total costs of obtaining
the contract (marketing costs) will be $22,000. Domestic business would be unaffected by this
order. What is the minimum unit price Hospital Supply should consider for this order of 1,000
units?

Variable costs
Materials $550
Labour 825
Overhead 420
Shipping costs 410
Ordering costs ($22,000/1000 units) 22
Unit Revenue $2227
SAPKALE LALIT
PGP/1348/06
5. An inventory of 200 units of an obsolete model of the hoist remains in the stockroom. These
must be sold through regular channels at reduced prices or the inventory will soon be valueless.
What is the minimum price that would be acceptable in selling these units?
The acceptable minimum price for the obsolete model is the total variable marketing cost of $275.
It is given in the case that it’ll be sold thru regular channels. It shouldn’t have any share in the
fixed costs since the expense allocated to the product has been long charged to the period when
the old hoist was manufactured.

6. A proposal is received from an outside contractor who will make 1,000 hydraulic hoist units per
month and ship them directly to Hospital Supply's customers as orders are received from Hospital
Supply's sales force. Hospital Supply's fixed marketing costs would be unaffected, but its variable
marketing costs would be cut by 20 percent (to $220 per unit) for these 1,000 units produced by
the contractor. Page 483Hospital Supply's plant would operate at two-thirds of its normal level,
and total fixed manufacturing costs would be cut by 30 percent (to $1,386,000). What in-house
unit cost should be used to compare with the quotation received from the supplier? Should the
proposal be accepted for a price (i.e., payment to the contractor) of $2,475 per unit?
The $2,475 (payment to the contractor) purchase price will slightly decrease income and should
not be accepted. Kindly see computation below.

Variable costs
Materials $550
Labor 825
Overhead 420
Variable marketing opportunity cost ($275- 55
220)
Fixed manufacturing opportunity cost 594
[($1,980,000-$1,386,000)/1000]

7. Assume the same facts as above in Question 6 except that the idle facilities would be used to
produce 800 modified hydraulic hoists per month for use in hospital operating rooms. These
modified hoists could be sold for $4,950 each, while the variable manufacturing costs would be
$3,025 per unit. Variable marketing costs would be $550 per unit. Fixed marketing and
manufacturing costs would be unchanged whether the original 3,000 regular hoists were
manufactured or the mix of 2,000 regular hoists plus 800 modified hoists was produced. What is
the maximum purchase price per unit that Hospital Supply should be willing to pay the outside
contractor? Should the proposal be accepted for a price of $2,475 per unit to the contractor? Break-
even volume in units and dollar
3,000 Regular Regular Regular Modified Total
Hoists Produced (in) (Out)
in-House
SAPKALE LALIT
PGP/1348/06
Total 13,050,000 8,700,000 4,350,000 3,960,000 17,010,000
Sales
Variable 5,385,000 3,590,000 2,420,000 6,010,000
Manufactu
ring
Variable 825,000 550,000 220,000 440,000 1,210,000
Marketing
Contributi 6,840,000 4,560,000 4,130,000 1,100,000 9,790,000
on Margin
Fixed 2,310,000 2,310,000
Marketing
Income 2,550,000 5,500,000- X

To get maximum payment:

$2,550,000 = $5,500,000 – X
X = 5,500,000 - 2,550,000
X = $2,950,000

CASE STUDY - Bill French

1. What are the assumptions implicit in Bill French's determination of his company's
break-even point?
Assumptions:

1.One breakeven point for company and whole products

2.constant product mix
3.No change on fixed costs for the next year if production rate changes.

He has assumed that there is just one breakeven point for the firm (by taking the average
of the 3 products). He has also assumed that the sales mix will remain constant. Since the
capacity is being expanded to increase production of Product C, it could be assumed that
this increase should be allocated to this product. Production of Product A is to be scaled
down, but its level of fixed costs has been assumed to be unchanged.

2. On the basis of French's revised information, what does next year look like:
A. Break-even units= Fixed Cost/ (Selling price – Variable Cost Per Unit) Break-even
units= $3,690,000/ (6.948 - 3.56) = 1,035,686 units
The breakeven unit for the aggregate production is 1035686 units
B. To pay the extra dividend of 50% and to retain the profit of $150000 we need to have
the profit after taxes as $600000. As half of the revenues go to the government as taxes
therefore the total revenues before tax deduction should be equal to $1200000.
SAPKALE LALIT
PGP/1348/06

Operating income after taxes ($450000 dividend + $150000 profits) $600000

Selling price $6.95
Variable cost per unit $3.39
Contribution margin per unit $3.56
Operating income before tax (assuming 50% of the revenue goes as tax to the government)
$ 1200000
Total Fixed Cost $3690000
No of units required to be produced = (FC + Operating income)/Contribution = 1373595

C. Operating income after taxes ($450000 dividend + $150000 profits) $450000

Operating Income after taxes ($450000 $450000
divided + $150000 profits)
Selling Price $6.95
Variable Cost per unit $3.73
Contribution Margin per unit $3.2
Operating income before tax (Assuming $900000
50% of the revenue goes as tax to the
government)
Total Fixed Cost $3690000
No. of units required to be produced = 1434375
(FC + Operating income)/ Contribution

D. Operating income after taxes ($450000 dividend + $150000 profits) $600000

Contribution margin per unit $3.2
Operating income before tax (assuming 50% of the revenue goes as tax to the government)
$1200000
Total Fixed Cost $3690000
No of units required to be produced = (FC + Operating income)/Contribution =1528125

3. Can the break-even analysis help the company decide whether to alter the existing
product emphasis? What can the company afford to invest for
Additional C" capacity?

Break even analysis can be used to decide whether to alter the existing product emphasis
or not. For example, in this case, if we refer last year’s data, we can see that the product C
is not economically feasible to manufacture at $2.40 / unit. Following table gives the
analysis for checking whether the company can afford to invest in additional “C” capacity.
SAPKALE LALIT
PGP/1348/06
Total Number of Units Produced 950000
Sale Price $4.8
Sale Revenue $4560000
Variable cost $1.50
Total Variable cost $1425000
Contribution $3135000
Fixed Cost $1170000
Investment the company can afford $1965000

4. Calculate each of the three products' break-even points using the data in Exhibit 3.
Why is the sum of these three volumes not equal to the 1,100,000 units aggregate
break-even volume?
Column Aggregate A B C
Sales at full capacity (units) 2000000
Actual Sales Volume
1500000 600000 400000 500000
(units)
Unit Sales Price $7.20 $10 $9 $2.40
Sales Revenue $10,800,000 $6,000,000 $3,600,000 $1,200,000
Variable Cost per unit $4.50 $7.50 $3.75 $1.50
Contribution margin per
$2.70 $2.50 $5.25 $0.90
unit
Total Variable Costs $6,750,000 $4,500,000 $1,500,000 $750,000
Fixed Costs $2,970,000 $960,000 $1,560,000 $450,000
Profit $1,080,000 $540,000 $540,000 $1200000
RATIOS
Variable cost to sales 0.625 0.75 0.41666 70.625
Unit contribution to sales 0.375 0.25 0.58333 30.375
Utilization of capacity 75.00% 30% 58% 37.50%
Break Even Point (units) 1100000 384000 297143 500000

5. Is this type of analysis of any value'?' For what can it be used?

The following are the benefits of the breakeven analysis:

• The breakeven analysis helps understand and formulate the relationship between
costs (fixed and variable), output and profit. The technique can be used to set sales
targets and/or prices to generate target profits.
• In a wide product range, the analysis helps to find out which products are
performing well and which are leading to losses.
• It is also versatile enough to include items like donations, wage increases, etc. that
directly or indirectly affect costs.