Accelerat ing t he world's research.

Hospital Supply Inc. Background of

the Case
Julius Ochieng

Related papers Download a PDF Pack of t he best relat ed papers 

. Const ruct ion Purchasing & Supply Chain Management

Rona Librada
Hospital Supply Inc.
CASE ANALYSIS PRESENTED BY GROUP 1:
PAT R I C I A C O, A N D R H EA A R N U C O, RO B M I C L AT, S H I E N E L M UJA R
D E L A SA L E U N I V E RS I T Y - M BA
Background of the Case
Hospital Supply, Inc. produced hydraulic hoists
that were used by hospitals to move bedridden
patients.
The cost of manufacturing and marketing
hydraulic hoists at the company’s normal volume
of 3,000 units per month are shown in Table 1:
Table 1: Cost per Unit for
Hydraulic Units
Unit manufacturing costs:
Variable materials $550
Variable labor $825
Variable overhead $420
Fixed overhead $600
Total unit manufacturing costs $2,455
Unit marketing costs:
Variable $275
Fixed overhead $770
Total unit marketing costs $1,045
Total unit costs $3,500
Background of the Case
Selling price is $4,350 per unit, based on
the company’s normal volume of 3000 units.
Problem Statement
Hospital Supply Inc. has an opportunity to
increase its profits with the following course of
actions:
•Cutting the selling price.
•Accepting a contract offer from the federal
government.
•Entering a foreign market.
•Partnering with an outside contractor.
Objective
The objective of this case is to recommend
which among the opportunities should Hospital
Supply Inc. take in order to become more
profitable.
Areas to Consider: Break-Even
Analysis
First, it is important to determine the break-
even volume based on the company’s current
costs and selling price of its products.
The break-even volume can be expressed in
number of units or revenue. It is calculated as
follows:
Areas to Consider : Break-Even
Analysis
���
− � =
� � � �

Where:
Fixed costs = total fixed costs
(fixed cost per unit times normal volume)
Unit contribution margin = selling price – variable cost per unit
Areas to Consider : Break-Even
Analysis
+ ∗
− � =
, −

, ,
− � =
,

− � = ,
Areas to Consider : Break-Even
Analysis
���
− =
� �

Where:
Fixed costs = total fixed costs
(fixed cost per unit times normal volume)
Contribution percent =
(selling price – unit variable cost) / selling price
Areas to Consider Break-Even
Analysis
+ ∗
− =
, − ,
,

− =$ , ,
 Total Cost / Revenue in USD

10000000

12000000

14000000
2000000

4000000

6000000

8000000
0
0
50
100
150
200
250
300
350
400
450
500
550
600
650
700
750
800
850
900
950

PROFITGRAPH FOR HOSPITAL SUPPLY, INC.

1000
1050
1100
1150
1200
1250
1300
1350
Volume (no. of units)

1400
1450
1500
1550
1600
1650
1700
1750
1800
1850
1900
1882 units, $8185461

1950
2000
2050
2100
2150
2200
2250
2300
2350
2400
2450
2500
2550
2600
2650
2700
2750
2800
2850
2900
2950
3000
Rev
Cost
Alternative 1: Decrease Selling Price
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
behavior patterns implied by the data in Table 1 are
correct, would you recommend that this action be
taken? What would be the impact on monthly sales,
costs, and income?
Alternative 1: Decrease Selling Price
Impact on Monthly Sales:

Before After

Price 4,350 3,850

Quantity 3000 3500

Total Sales $13,050,000 $13,475,000

Alternative 1: Decrease Selling Price
Impact on Cost:
Unit Price Before After
Variable Costs
Variable materials 550 1650000 1925000
Variable labor 825 2475000 2887500
Variable overhead 420 1260000 1470000
Variable marketing 275 825000 962500
Total Variable Costs $6,210,000 $7,245,000

Fixed Costs
Fixed overhead 660 1980000 1980000
Fixed marketing 770 2310000 2310000
Total fixed costs $4,290,000 $4,290,000
Total Costs $10,500,000 $11,535,000
Alternative 1: Decrease Selling Price
Impact on Income:
Before After

Total Sales 13,050,000 13,475,000

Total Costs (10,500,000) (11,535,000)

Income $2,550,000 $1,940,000

Alternative 1: Decrease Selling Price
Advantage: Total sales will be higher
Disadvantages: Costs will be higher. Income will be lower.
Recommendation:
1. Stop reduction of sales price and continue with current
pricing and production capacity;
2. Lowering sales price reduces total sales and income while
cost remains at steep level (unit price remains the same).
Alternative 2: Contract Offer from the
Federal Government
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 unusually large number of rush of
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?
Alternative 2: Contract Offer from the
Federal Government
Comparison:
Without Govt. With Government Contract
Contract Regular Government Total Difference
No. of units 4000 3500 500 4000
Revenue $17,400,000 $15,225,000 $1,420,000 $16,645,000 $(755,000)

Variable mfg. (6,282,500.00) (897,500.00) --

(7,180,000.00) (7,180,000.00)

Variable mktg. costs (962,500.00) --

(1,100,000.00) (962,500.00) 137,500.00

Contribution margin 7,980,000.00 522,500.00

9,120,000.00 8,502,500.00 (617,500.00)

Fixed mfg. costs --

(1,980,000.00) (1,980,000.00)

Fixed mktg. costs --

(2,310,000.00) (2,310,000.00)
Income $ 4,830,000 $ 4,212,500 $(617,500)
Alternative 2: Contract Offer from the
Federal Government
Recommendation:

Do NOT accept the offer, income will decrease by 13%.

Alternative 3: Entering a Foreign
Market
Hospital Supply has an opportunity to enter a foreign market
in which price competition is keen. An attraction of 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?
Alternative 3: Entering a Foreign
Market
Minimum unit price:
Variable Costs
Materials $550.00
Labor 825
Overhead 420
Shipping Costs 410
Ordering Cost ($22,000/1000
22
units)
Unit Revenue $2,227
Alternative 3: Entering a Foreign
Market
Recommendation:

Minimum unit price that should be set is $2,227. The differential

costs caused by the 1,000 unit order will just be uncovered.
Alternative 4: Selling an Obsolete
Model
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?
Alternative 4: Selling an Obsolete
Model
Recommendation:
The minimum acceptable price that should be set
for the obsolete product is $275.Given that it
must be sold through regular channels.
Moreover, it shouldn’t have any share in the fixed
costs since the expense allocated to the hoist has
been long incurred and thus unrecovered.
Alternative 5: Outside Contractor
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% (to 220 per unit) for these
1,000 units produced by the contractor. Hospital Supply’s plant would
operate a two-thirds of its normal level, and total fixed manufacturing
costs would be cut by 30% (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?
Alternative 5: Outside Contractor
Comparison:
Normal With Contract
Total Sales 13,050,000 13,050,000
Total Variable Marketing Cost (825,000) (770,000)
Total Fixed Marketing Cost (2,310,000) (2,310,000)
Total Variable Manufacturing Cost (5,385,000) (3,590,000)
Total Fixed Manufacturing Cost (1,980,000) (1,386,000)

Contractor payment X

Income 2550000 4994000 - X

Alternative 5: Outside Contractor
Compute for the acceptable amount range that should be paid to the
contractor:
, , ≤ , , −�
� ≤ , , − , ,
� ≤$ , ,
Thus, the price per unit produced by the contractor is $ 2,444.
To become profitable, the company should accept the proposal if the
contractor payment is less than $ 2,444,000.
Accepting the contractor’s offer will cost you to pay $ 2,475,000.
Alternative 5: Outside Contractor
Advantage: Lower variable costs
Disadvantage: Additional cost for the contractor’s
payment will decrease the company’s income,
compared to the normal production scenario.
Recommendation: Reject the contractor’s proposal.
Alternative 6: In-house Production of
Modified Hoists and Outside Contractor
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 cost would be $550 per unit. Fixed
marketing and manufacturing cost 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.
Alternative 6: In-house Production of
Modified Hoists and Outside Contractor
Comparison:
Current Alternative
Regular operation In-house Contractor Modified Hoists Total

Units produced 3000 2000 1000 800

Total Sales 13,050,000 8,700,000 4,350,000 3,960,000 17,010,000
Variable manufacturing costs (5,385,000) (3,590,000) - (2,420,000) (6,010,000)
Variable marketing costs (825,000) (550,000) (220,000) (440,000) (1,210,000)
Contribution margin 6,840,000 4,560,000 4,130,000 1,100,000 9,790,000
Fixed manufacturing costs (1,980,000) - - - (1,980,000)
Fixed marketing costs (2,310,000) - - - (2,310,000)
Contractor payment (X)
5,500,000 -
Income 2,550,000 X
Alternative 6: In-house Production of
Modified Hoists and Outside Contractor
Compute for the maximum purchase price per unit that Hospital Supply
should be willing to pay the outside contractor:
, , ≤ , , −�
� ≤ , , − , ,
� ≤$ , ,
Thus, the price per unit is equal to $2,950.
To become profitable, the company should accept the proposal if the
contractor payment is less than $ 2,950,000.
Accepting the contractor’s offer will cost you to pay $ 2,475,000.
Alternative 6: In-house Production of
Modified Hoists and Outside Contractor
Advantage:
Total sales is higher because of the additional production of modified
hoists.
Contractor’s proposal is favorable to both parties because it will translate
to a higher income for the company because the expense that will be paid
to the contractor is lower than the calculated amount that should be paid
to obtain a profit.
Disadvantage: Total variable costs is higher.
Recommendation: Accept the proposal.
Conclusion
The following alternatives are favorable to
Hospital Supply, Inc.:
Enter the foreign market.
Sell the obsolete products.
Accept the outside contractor’s proposal and
produce modified hoists.