Health Care Financial Management II Practical Exercise in Sunk Cost Analysis On

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Health Care Financial Management II Practical Exercise in Sunk Cost Analysis On January 1, 2007, Mr. DMB, CFO for the Warehouse Health System, purchased a new CT scan for the radiology department after evaluating cost and quality of CT scans from five (5) vendors. The purchase price of the CT scan was $1 million dollars. The cost per procedure in technical and professional labor and supplies is $650 dollars.   On February 1, 2007, one of the radiologist on staff informed Mr. DMB of a CT scan that would significantly decrease the cost per procedure to $325 per procedure. The purchase price for CT scan # 2 is $1.1 million dollars. 1) What should Mr. DMB, CFO do? Should he purchase CT Scan # 2?   2) What additional informantion is needed to make a decision to purchase CT Scan # 2? 3) What could have been done to avoid this situation, if at all? 4) Utilize the speadsheet model to anaylze changes in cost per procedure, revenue changes, volume changes. 5) What suggestions would you provide Mr. DMB if a) he did purchase CT Scan # 2, b) if he did NOT purchase     CT Scan # 2? Assume the volume is projected to cap at 5000 procedures. Janaury 1, 2007 February 1, 2007 CT Scan # 1 CT Scan # 2 Initial Cost ($1,000,000) ($1,100,000) Volume: # of procedures 5000 5000 cost per procedure $650 $325 Total Variable Cost $3,250,000 $1,625,000 Net Revenue per procedure $1,000 $1,000 Net Revenue $5,000,000 $5,000,000 Net profit without fixed cost $1,750,000 $3,375,000 Add Back Initial Cost ($1,000,000) ($1,100,000) Profit $750,000 $2,275,000 Health Care Financial Management II Practical Exercise in Sunk Cost Analysis On January 1, 2007, Mr. DMB, CFO for the Warehouse Health System, purchased a new CT scan for the radiology department after evaluating cost and quality of CT scans from five (5) vendors. The purchase price of the CT scan was $1 million dollars. The cost per procedure in technical and professional labor and supplies is $650 dollars.   On February 1, 2007, one of the radiologist on staff informed Mr. DMB of a CT scan that would significantly decrease the cost per procedure to $325 per procedure. The purchase price for CT scan # 2 is $1.1 million dollars. 1) What should Mr. DMB, CFO do? Should he purchase CT Scan # 2?   2) What additional informantion is needed to make a decision to purchase CT Scan # 2? 3) What could have been done to avoid this situation, if at all? 4) Utilize the speadsheet model to anaylze changes in cost per procedure, revenue changes, volume changes. 5) What suggestions would you provide Mr. DMB if a) he did purchase CT Scan # 2, b) if he did NOT purchase     CT Scan # 2? Assume the volume is projected to cap at 5000 procedures. Janaury 1, 2007 February 1, 2007 CT Scan # 1 CT Scan # 2 Initial Cost ($1,000,000) ($1,100,000) Volume: # of procedures 5000 5000 cost per procedure $650 $325 Total Variable Cost $3,250,000 $1,625,000 Net Revenue per procedure $1,000 $1,000 Net Revenue $5,000,000 $5,000,000 Net profit without fixed cost $1,750,000 $3,375,000 Add Back Initial Cost ($1,000,000) ($1,100,000) Profit $750,000 $2,275,000

Explanation / Answer

Health Care Financial Management II Practical Exercise in Sunk Cost Analysis On January 1, 2007, Mr. DMB, CFO for the Warehouse Health System, purchased a new CT scan for the radiology department after evaluating cost and quality of CT scans from five (5) vendors. The purchase price of the CT scan was $1 million dollars. The cost per procedure in technical and professional labor and supplies is $650 dollars.   On February 1, 2007, one of the radiologist on staff informed Mr. DMB of a CT scan that would significantly decrease the cost per procedure to $325 per procedure. The purchase price for CT scan # 2 is $1.1 million dollars. 1) What should Mr. DMB, CFO do? Should he purchase CT Scan # 2?   2) What additional informantion is needed to make a decision to purchase CT Scan # 2? 3) What could have been done to avoid this situation, if at all? 4) Utilize the speadsheet model to anaylze changes in cost per procedure, revenue changes, volume changes. 5) What suggestions would you provide Mr. DMB if a) he did purchase CT Scan # 2, b) if he did NOT purchase     CT Scan # 2? Assume the volume is projected to cap at 5000 procedures. Janaury 1, 2007 February 1, 2007 CT Scan # 1 CT Scan # 2 Initial Cost ($1,000,000) ($1,100,000) Volume: # of procedures 5000 5000 cost per procedure $650 $325 Total Variable Cost $3,250,000 $1,625,000 Net Revenue per procedure $1,000 $1,000 Net Revenue $5,000,000 $5,000,000 Net profit without fixed cost $1,750,000 $3,375,000 Add Back Initial Cost ($1,000,000) ($1,100,000) Profit $750,000 $2,275,000 1) Mr DMB should purchase the CT Scan 2 because it is resulting in increased profit. 2) The information regarding the life of the machines and cost of capital is required to take the decision. 3) The machine can be manufactured inhouse as well to avoid the decision of selection of vendors. 4) Increase in Cost Per Procedure Janaury 1, 2007 February 1, 2007 CT Scan # 1 CT Scan # 2 Initial Cost ($1,000,000) ($1,100,000) Volume: # of procedures 5000 5000 cost per procedure $700 $375 Total Variable Cost $3,500,000 $1,875,000 Net Revenue per procedure $1,000 $1,000 Net Revenue $5,000,000 $5,000,000 Net profit without fixed cost $1,500,000 $3,125,000 Add Back Initial Cost ($1,000,000) ($1,100,000) Profit $500,000 $2,025,000 Mr DMB should purchase the CT Scan 2 because it is resulting in increased profit. Decrease in Revenue per procedure Janaury 1, 2007 February 1, 2007 CT Scan # 1 CT Scan # 2 Initial Cost ($1,000,000) ($1,100,000) Volume: # of procedures 5000 5000 cost per procedure $650 $325 Total Variable Cost $3,250,000 $1,625,000 Net Revenue per procedure $800 $800 Net Revenue $4,000,000 $4,000,000 Net profit without fixed cost $750,000 $2,375,000 Add Back Initial Cost ($1,000,000) ($1,100,000) Profit ($250,000) $1,275,000 Mr DMB should purchase the CT Scan 2 because it is resulting in increased profit. Decrease in Revenue per procedure Janaury 1, 2007 February 1, 2007 CT Scan # 1 CT Scan # 2 Initial Cost ($1,000,000) ($1,100,000) Volume: # of procedures 6000 6000 cost per procedure $650 $325 Total Variable Cost $3,900,000 $1,950,000 Net Revenue per procedure $800 $800 Net Revenue $4,800,000 $4,800,000 Net profit without fixed cost $900,000 $2,850,000 Add Back Initial Cost ($1,000,000) ($1,100,000) Profit ($100,000) $1,750,000 Mr DMB should purchase the CT Scan 2 because it is resulting in increased profit. 5a) Mr DMB should try to increase its volume because now the variable cost is reduced and he should try to take benefit from the opportunity by selling more. 5b) In case the machine is not purchased, Mr DMB should try to decrease the variable cost so as to increase the overall profits.

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