Question

MA 117 Lab 1

In this lab, you will need to write equations, perform calculations, and make judgements. All equations and calculations should be included in your lab write-up. All judgements should be explained and justified in complete sentences referencing your calculations.

1. Hospital Administration

Southwest Hospital has an operating room used only for eye surgery. The annual cost of rent, heat, and electricity for the operating room and its equipment is $360,000, and the annual salaries of the people who staff this room total $540,000.

Each surgery performed requires the use of $760 worth of medical supplies and drugs. To promote goodwill, every patient receives a bouquet of flowers the day after surgery. In addition, one-quarter of the patients require dark glasses, which the hospital provides free of charge. It costs the hospital $30 for each bouquet of flowers and $40 for each pair of glasses.

The hospital receives a payment of $2000 for each eye operation performed.

1. Identify the revenue per case and the annual fixed and variable costs for running the operating room.
2. How many eye operations must the hospital perform each year in order to break even?
3. Southwest Hospital currently averages 70 eye operations per month. One of the nurses has just learned about a machine that would reduce by $100 per patient the amount of medical supplies needed. It can be leased for $100,000 annually. Keeping in mind the financial cost and benefits, advise the hospital on whether it should lease this machine.
4. An advertising agency has proposed to the hospital’s president that she spend $20,000 per month on television and radio advertising to persuade people that Southwest Hospital is the best place to have any eye surgery performed. Advertising account executives estimate that such publicity would increase business by 40 operations per month. If they are correct and if this increase is not big enough to affect fixed costs, what impact would this advertising have on the hospital’s profits?
5. In case the advertising agency is being overly optimistic, how many extra operations per month are needed to cover the cost of the proposed ads?
6. If the ad campaign is approved and subsequently meets its projections, should the hospital review its decision about the machine discussed in Question 3?

Answer 1

Question 1:

The revenue per case and the annual fixed and variable costs for running the operating room are determined as below:

Revenue Per Case = Amount Received for Each Eye Operation Performed = $2,000

Annual Fixed Costs = Annual Cost of Rent, Heat, and Electricity for the Operating Room and its Equipment + Annual Salaries = $900,000

Variable Costs Per Case = Cost of Medical Supplies Per Case + Cost of Bouquet Flowers + Cost of Glasses = 760 + 30 + 40*1/4 = $800 per case

Annual Variable Costs = Total Number of Cases*Variable Costs Per Case = 70*12*800 = $672,000

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Question 2:

The number of eye operations to be performed each year to break even is calculated as follows:

Number of Eye Operations to Break Even = Annual Fixed Costs/(Revenue Per Case - Variable Costs Per Case)

Substituting values in the above formula, we get,

Number of Eye Operations to Break Even = 900,000/(2,000 - 800) = 750 eye operations

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Question 3:

In order to decide whether we should lease the machine or not, we will have to calculate profit under each scenario as below:

	Profit Calculation
	When Machine is Not Leased	When Machine is Leased
Revenue (840*2,000)	1,680,000	1,680,000
Less Variable Costs	672,000 (840*800)	588,000 (840*700)
Contribution Margin	1,008,000	1,092,000
Less Fixed Costs	900,000	1,000,000 (900,000 + 100,000)
Profit	$108,000	$92,000

Based on the above calculations it can be seen that the profit decreases by $16,000 (108,000 - 92,000) when the machine is leased. Therefore, the machine shouldn't be leased.

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Question 4:

The impact of advertising on hospital profits is calculated as follows:

	Profit Calculation
	When Advertising is Not Done	When Advertising is Done
Revenue	1,680,000 (840*2,000)	2,640,000 [(840 + 40*12)*2,000]
Less Variable Costs	672,000 (840*800)	1,056,000 [(840 + 40*12)*800]
Contribution Margin	1,008,000	1,584,000
Less Fixed Costs	900,000	1,140,000 (900,000 + 20,000*12)
Profit	$108,000	$444,000

Based on the above calculations it can be seen that  the hotel's profits will increase to $444,000 if it undertakes advertising.

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Question 5:

The number of extra operations needed to cover the cost of proposed ads is calculated as below:

Number of Extra Operations to Cover Cost of Proposed Ads (Annual) = Annual Fixed Costs Including Advertising Costs/(Revenue Per Case - Variable Cost Per Case) - Current Number of Operations = 1,140,000/(2,000 - 800) - 840 = 110 operations

Now, we can calculate the number of extra operations to be performed monthly as follows:

Number of Extra Operations to Cover Cost of Proposed Ads (Monthly) = Number of Extra Operations (Annual)/12 = 110/12 = 9.167 extra operations

Based on the above calculations it can be concluded that the hospital needs to perform 9.167 extra operations or 10 operations to cover the cost of proposed ads.

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Question 6:

We will have to calculate the revised profit in order to take the decision as below:

Revenue  [(840 + 40*12)*2,000]	2,640,000
Less Variable Costs [(840 + 40*12)*700]	924,000
Contribution Margin	1,716,000
Less Fixed Costs (900,000 + 100,000 + 240,000)	1,240,000
Profit	$476,000

Based on the above calculations it can be seen that with advertising campaign and leased machine, the hospital's profit increases from $444,000 (as calculated in question 5) to $476,000. Therefore, the hospital can review its decision about the machine and consider it taking on lease.