March 9, 2011

[CASE 6 GROUP 2]

Hospital Supply, Inc. produces a device used by hospitals in moving bedridden patients. In this case, we see how different market conditions and pricing could affect the profitability of this device.
Exhibit 1 Break-even computation Break-even volume in units: Revenue per unit Variable Costs per unit Contribution Margin per unit Total Fixed Costs Contribution Margin per unit

4,350.00 (2,070.00) 2,280.00 4,290,000.00 2,280.00

Appendix 1 and 2 shows the numbers given in the case where we get an income per unit of 850 and total income of 2,550,000. With these, we are able to compute for the companys break-even volume of 1882 units and break-even revenues of 8,186,700 (Exhibit 1).

Marketing conditions are welcoming the increase of production if the price of the device is decreased. With this, we decide the alternative to be undertaken by the company that would give the best results. Break-even volume in units 1,881.58 In Appendix 3 and 4, we see how the increase or 1882 units in volume decreases fixed costs but with the Break-even revenues: corresponding decrease in price, income per unit is still Break-even volume in units 1,882 ultimately reduced to 554.29 and total income to Sales per unit x 4,350.00 1,940,000. Comparing these to the numbers of the Break-even revenues 8,186,700.00 company upon retaining its original production, we see a 3% increase in sales and 10% in costs, resulting to a total of 24% decrease in profitability (Exhibit 2). Increasing the production while decreasing the price would prove detrimental. The company would be better off in pursuing their original production plan.
Exhibit 2 Impact of Increase in Production and Decrease In Selling Price on Sales, Costs, And Income Sales Costs Income Before change 13,050,000.00 10,500,000.00 2,550,000.00 After change 13,475,000.00 11,535,000.00 1,940,000.00 Difference 425,000.00 1,035,000.00 (610,000.00) Percentage 3.26% 9.86% -23.92%

Unusually large rush orders from customer are pushing the company in producing at full capacity during March. The government, however, is offering a contract of 500 units in the same month. Hospital Supply must now decide whether to decline the government order and accommodate its regular customers, or accept the order. Appendix 5 and 6 shows the computations of total income in both Exhibit 3 Comparison of Full In-house Production and Acceptance of Government Contract cases where we get 4,830,000 and 4,212,500, respectively. We see that All In-house With government Difference the company would have a higher In-flows 17,400,000.00 15,500,000.00 (1,900,000.00) profit if they choose to decline the 11,287,500.00 (1,282,500.00) government order (Exhibit 3). The Outflows 12,570,000.00 4,830,000.00 4,212,500.00 (617,500.00) best decision would be producing for Income customers at full capacity.
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March 9, 2011

[CASE 6 GROUP 2]

An opportunity to enter a competitive foreign market is seen by Hospital Supply where 1000 units are being sought at below-market price. In Appendix 7 we compute for the total costs necessary in entering this market. With the variable costs and additional marketing and shipping costs, these amount to a total of 2,227,000. Dividing this with the number of units sought, we get a minimum unit price of 2,227 (Exhibit 4).
Exhibit 4 Computation of Minimum Unit Price for Entering Foreign Market Total costs to be incurred Divided by number of units Minimum unit price 2,227,000.00 1000 2,227.00 Exhibit 5 Computation of Minimum Unit Price for Disposing Obsolete Model Total costs to be incurred Divided by number of units Minimum unit price 700,000.00 200 3,500.00

On the other hand, 200 units of an obsolete model of the hydraulic hoists are still in the stockroom. The company must be able to sell these units before they are rendered valueless. We compute for the total costs incurred for the products of 700,000 in Appendix 8. With this, we get an acceptable minimum unit price of 3,500 (Exhibit 5).

The last conditions give Hospital Supply an opportunity to partly outsource 1000 units of their production. Contemplating the reduction of marketing and fixed overhead costs, and the pricing of the contracted units, the company must decide whether Exhibit 6 Computation of In-house Unit Costs the proposal of the outside contractor should be Capacity is used for Normal Production accepted. Total costs to be incurred 10,500,000.00 Appendix 9 shows income computed as Divided by number of units 3000 2,550,000 if production is fully done in-house. Assuming the company will operate at normal Minimum unit price 3,500.00 production, we get a minimum unit cost of 3,500 (Exhibit 6). Appendix 10 to 12 shows results of the company if it agrees on partially outsourcing its production. In Appendix 10 and 11, we compute income from the units done in-house as 1,634,000 while income from the contracted units as 885,000. With these, we are able to get total income of 2,519,000, as shown in Appendix 12. Comparing sales and costs of both fully in-house and partly outsourced production, we see that there is additional 31,000 to be incurred if Exhibit 7 Comparison of Full In-House and the company outsources at 2,475 per unit Partly Outsourced Production (Exhibit 7). The proposal of the outside All In-house Partly outsourced Difference contractor should, therefore, be declined. Sales 13,050,000.00 13,050,000.00 The company should opt to produce all the Costs 10,500,000.00 10,531,000.00 31,000.00 units in-house as this will give the Income 2,550,000.00 2,519,000.00 (31,000.00) company the best results.
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March 9, 2011

[CASE 6 GROUP 2]

If idle capacity is used in producing 800 units of modified hydraulic hoists, however, the decision would be different. In Appendix 13 to 15, we appropriately allocate fixed costs to the units produced and outsourced where we get income from normal, modified and contracted hoists of 1,929,924.81, 47,969.92 and 1,047,105.26, respectively. This amounts to a total income of 3,025,000 as computed in Appendix 12. Comparing these to production done purely in-house, we find that income would be increased by 475,000, rendering outsourcing and production of modified hoists more beneficial for the company (Exhibit 8).
Exhibit 8 Comparison of Full In-House and Partly Outsourced Production with Production Of Modified Hoists All In-house 13,050,000.00 10,500,000.00 2,550,000.00 Partly outsourced 17,010,000.00 13,985,000.00 3,025,000.00 Difference 3,960,000.00 3,485,000.00 475,000.00

Sales Costs Income

We further compute for the maximum price of the contracted units up to which the proposal would still be considered acceptable. From sales, we would deduct costs incurred outside the contract and income required to break even. This would give us cost allowed to be incurred for the outsourced units as 2,950,000. With this, we compute the maximum price for each unit as 2,950 (Exhibit 9).

Exhibit 9 Computation of Maximum Price for the Acceptance of Proposal from Outside Contractor with the Production Of Modified Hoists Sales Less: Costs other than contract price Income to break-even Costs that may be incurred for contract Cost per unit 17,010,000.00 11,510,000.00 2,550,000.00 2,950,000.00 2,950.00

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