MBAO571 Week 9

Apply Your Understanding (AYU) Worksheet

Pod #: 1
Members: Nicolle Potvin, Matt McGowan, Krista Bangrazsi, Dilip Ganesan
Date: 3/11/23

Exercise 4-50 Dropping Product Lines

Freeflight Airlines is presently operating at 70 percent of capacity. Management of the airline is considering
dropping Freeflight’s routes between Europe and the United States. If these routes are dropped, the revenue
associated with the routes would be lost and the related variable costs saved. In addition, the company’s total fixed
costs would be reduced by 20 percent. Segmented income statements for a typical month appear as follows (all
amounts in millions of dollars).

Required Prepare a differential cost schedule like the one in Exhibit 4.8 to indicate whether Freeflight should drop
the routes between Europe and the United States.

Differential Cost Schedule (in million $)

Status Quo (A) Alternative (B) Difference (B–A)

Sales Revenue, Status Quo: (3.4+2.6+2.8) 8.8 6 -2.8

Alternative: (3.4+2.6)

Total Variable Cost, Status Quo: (1.4+1.0+1.5) 3.9 2.4 -1.5

Alternative: (1.4+1.0)

Total Fixed Cost, Status Quo: (1.7+1.3+1.4) 4.4 3.52 -0.88

Alternative: (4.4 x (1-20%))

Operating Profit (loss) (Sales - Costs) 0.5 0.08 -0.42

 Problem 4-68: Expanding Surgical Units in a Hospital

University Hospital has two separate units that are part of the hospital but are two separate facilities. The first is the
main hospital that performs emergency room functions, surgeries, and recovery. Separate from the main hospital is
an outpatient surgery center. In an effort to control costs, some of the patients that need minor surgeries are routed
to the outpatient surgery center. The outpatient surgery center treats patients in three activity centers: (1) Surgery,
(2) Phase I recov-ery, where patients recover while the patients are still asleep, (3) Phase II recovery, where patients
recover while they are awake. Phase II recovery ends when the patients go home. Daily capacities and production
levels are as follows.

The hospital receives an average of $1,000 per surgery. (The surgeon’s fee and the anesthesiolo-gist’s fee are billed
separately.) The variable cost per surgery is $300. There is sufficient demand for surgeries that the hospital could
perform 60 surgeries per day. Surgeries not performed by the outpatient surgery center are sent to the main
hospital’s regular surgery rooms. The variable cost per surgery for regular surgery in the main hospital is $700, while
the hospital still receives $1,000 per surgery.
The hospital management is considering the following alternatives:
1. Continue performing 30 surgeries per day at the outpatient surgery center and send the other 30 patients
per day to the main hospital’s regular surgery rooms.
2. Remodel the outpatient recovery rooms so that some of the Phase II space could be used for Phase I
recovery. This would cost $2,000 per day and enable the outpatient surgery center to perform 40 surgeries
per day. They would then send 20 patients to the hospital’s regular oper-ating rooms.
3. Expand the facilities of the outpatient surgery center at a differential cost of $15,000 per day so that it
could perform 60 surgeries per day, and service 60 patients per day in Phase I recov-ery. That would mean
the hospital would service 60 patients per day in Phase II recovery.

Required, Write a report to management of University Hospital recommending which of these alternatives it should
take. State your reasons why the hospital should accept your recommendation.

Alternative 1 Alternative 2 Alternative 3

Outpatient Surgery
Surgery Revenue (30 x 1,000) $30,000 (40 x 1,000) $40,000 (60 x 1,000) $60,000

Variable Costs (30 x 300) $9,000 (40 x 300) $12,000 (60 x 300) $18,000

Contribution Margin (30,000 - 9,000) $21,000 (40,000 -12,000) $28,000 (60,000 -18,000) $42,000
Differential Costs $2,000 $15,000
Net Income $21,000 (28,000 -2,000) $26,000 (42,000 - 15,000) $27,000

Main Hospital Surgery

Surgery Revenue (30 x 1,000) $30,000 (20 x 1,000) $20,000

Variable Costs (30 x 700) $21,000 (20 x 700) $14,000

Contribution Margin (30,000 - 21,000) $9,000 (20,000 -14,000) $6,000

 Differential Costs
Net Income $9,000 $6,000

Total Net Income (21,000 + 9,000) $30,000 (26,000 + 6,000) $32,000 $27,000

Give the alternatives, in order to maximize net income profits, the University Hospital should remodel the
outpatient recover rooms in order to perform 60 surgeries per day between both locations, with the least amount
of differential costs, resulting in $32,000 net income as opposed to the $30,000 or $27,000 that would be brought
in by the other alternatives.