Question

Hospital Hoist

Hospital Hoist is a supplier of hydraulic hoists for hospital use. These hoists are used a patients has a broken leg that needs to be elevated. The hoists typically sell at a price of €760 and the firm’s normal production and sales volume is 30,000 units/month. The firm uses a standard, full absorption, usage based cost system. Ignore taxes. The firm’s cost information is below.

Unit Manufacturing and Marketing Costs: (€)

Direct Materials                                              110

Direct Labor                                                    150

Variable Manufacturing Overhead                 50

Fixed Manufacturing Overhead                     120

Variable Marketing Costs                               50

Fixed Marketing Costs                                   140

A. Find the break-even volume in units (i.e., the volume where profits = 0).

B. Should Hospital Hoist increase monthly production and sales to 35,000 units while decreasing price to €680/unit?

C. The firm has 2300 units of an obsolete model. These must be sold through regular channels (thus incurring the normal variable marketing costs) at reduced prices, or the inventory will be worthless soon. Assume that every two obsolete units sold will displace the sale of one unit of the current model. What is the minimum acceptable price for these units?

D. An outside contractor wants to make and ship 10,000 units/month directly to the firm’s customers, but the customers would continue to pay Hospital Hoist directly. The firm’s variable marketing costs would be reduced by 20% for the 10,000 outsourced units. The firm would produce hoists in-house at 2/3 of its normal level and its total fixed manufacturing costs would be cut by 25%. What is the maximum per unit price that Hospital Hoist would be willing to pay the outside contractor?

E. Same facts as in Part D, but now if Hospital Hoist outsources the production of 10,000 hoists/month, the idle capacity could be used to produce 8000 modified hoists/month that could be sold for €900 each.   Variable manufacturing costs would be €550/unit and variable marketing costs would be €100/unit for the modified hoists. Total fixed costs would be same as when 30,000 regular hoists are produced. What is the maximum per unit price that Hospital Hoist would be willing to pay the outside contractor?

Answer 1

Solution:

A. Computaion of Break Even Point:

No of Units Sell per month = 30000

Sale price per unit = 760

Variable Cost per unit = (110+150+50+50) = 360

So Contribution per unit = (760 - 360) = 400

Total Fixed Cost = (120+140)*30000 = 7800000

Break Even Points in Units = (7800000/400) = 19500 Units

B. Decreased Price = 680 per unit

Variable Cost per unit = (110+150+50+50) = 360

So Contribution per unit = (680 - 360) = 320

No. of units sold = 35000

So total Cotribution = (35000*320) = 112,00,000

Less: Fixed Cost = 78,00,000

So Net Profit = 34,00,000

And incase of sale of 30000 units @760 per unit:

Total Contribution = (30000*400) = 120,00,000

Less: Fixed Cost = 78,00,000

So Net Profit = 42,00,000

So the production should not be increased to 35000 @ 680 per unit. Because if the production is increased

and the price is reduced to 680 then profit will be decreased by 8,00,000.

C. The minimum acceptable price should be the total variable cost of per unit i.e. 360. Any price above the same is better and the units

must be sold at 360 or any price more than that.

D. Due to this offer the following advantage will be occurred

Reduction in variable cost = (50*20%) = 10

Reduction in Fixed Cost = (120*3000)*25% = 900,000

So per unit benefit = (900,000/10,000) = 90

So offer price to the outsider contractor = (10+90) = 100

E. The Addition units contribution = (900-550-100) = 250

So the Total contribution = (250*8000) = 20,00,000

So per unit benefit allocated to the 10000 units = (20,00,000/10,000) = 200

So revised offer price = (100+200) = 300