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Case 6-1: Hospital Supply, Inc.

A. Introduction
This case consists examining various options of behavioral of costs in order to maximize profits. Hospital
Supply, Inc. manufactures hydraulic hoists and has a normal volume of 3,000 units per month. A
break-even analysis is used to determine the sales volume and prices at which the company would
profitably sell its product. Also, a number of scenarios are given in order to determine which options to
take to maximize profit or at least minimize loss.

B. Analysis
Question 1: According to exhibit 1 on page 500 in textbook variable costs per unit = $550 + $825 + $420
+ $275 = $ 2,070 and fixed costs per unit = $660 + $770 = $1,430.
Normal volume = 3,000 units and regular selling price = $4,350
Total fixed cost = 3,000 units *$1,430/unit = $4,290,000
Unit contribution = price/unit – variable cost/unit = $4,350 - $2,070 = $2,280
Contribution percent = $2,280/$4,350 = 0.524138

Question 2:
| |Regular price |With price reduction |Difference |
| | | |After - before |
|Quantity (units) |3,000 |3,500 |500 |
|Price ($) |4,350 |3,850 |-500 |
|Revenue $ (P x Q) |13,050,000 |13,475,000 |425,000 |
|Fixed costs |4,290,000 |4,290,000 |0 |
|Variable costs |6,210,000 |7,245,000 |1,035,000 |
|Total costs (FC+VC) |10,500,000 |11,535,000 | |

Income (with regular price) = Revenues –Total costs = $13,050,000 - $10,500,000 = $2,550,000
After price reduction, income = $13,475,000-$11,535,000 = $1,940,000

Question 3:
If government contract is accepted: income from government = 500 x unit contribution
= 500units x $2,280/unit = $1,140,000
Profit from fixed fee = $275,000
Fixed manufacturing cost prorated = ($660/unit) x 3000 units x 500units / 4000 units = 990,000,000/4000
= $247,500
Differential income = income – profit fixed fee – prorated fixed manufacturing costs
= 1,140,000 - $275,000 - $247,500 = -$615,500

Question 6:
Variable manufacturing costs per unit = $550 + $825 +$420 = $1,795
Variable marketing prospect per unit = $275 – $220 = $55
Fixed manufacturing prospect per unit = ($1,980,000 - $1,386,000)/1000 = 594,000/1,000 = $594
Total in-house cost = $1,795 + $55 + $594 = $2,444

Question 7:
| |Regular hoists |Regular hoists |Modified |Regular
|Total |
| |Without out |in-house |in-house |outsourced |With
out |
|Quantity (units) |3,000 |2,000 |800 |1,000 |
|
|Revenue R = (P x Q) |13,050,000 |8,700,000 |3,960,000 |4,350,000
|17,010,000 |

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Hospital Supply, Inc http://www.bignerds.com/print/Hospital-Supply-Inc/38435

|Variable costs |6,210,000 |4,140,000 |2,860,000 |220,000


|7,220,000 |

Income with outsourcing = $17,010,000 – ($4,290,000 + $7,220,000) – payment to outsourcing company.


Therefore, income = $5,550,000 – pmt to outsourcing co.

C. Solutions
1. - Break-even volume in units = fixed cost/unit contribution = $4,290,000/$2,280 = 1,882 units
- Break-even volume in sales = fixed cost/ contribution percent = $4,290,000/$0.524138 = $8,184,867
There is a slight difference using break-even volume x regular sales price.
Break-even in sales = $8,184,867 AND 1,882 units x $4,350/unit = $8,186,700

2. With reference to analysis section about question 2, reducing the price would result in reduction of
income, since $1,940,000 - $2,550,000 = $610,000. Even though price reduction has its advantages such
as increasing demand, it reduces income considerably in this case, and can potentially reduce product
availability. Therefore, I wouldn’t recommend this measure to take effect.

3. If the government contract is accepted, the negative differential income (-$615,500) in question 3
analysis indicates a loss, suggesting a bad deal. Therefore, I would suggest turning down the government
offer.

4. The minimum price to be considered = variable manufacturing costs plus shipping costs plus marketing
cost. Marketing cost/unit = $22,000/1,000 = $22. Therefore, the minimum acceptable price equals ($550
+ $825 + $420) + $410 + $22 = $2,227/ unit. At this price, there will be no profits. There are definitely
advantages in selling in foreign market such as new market opportunity which could increase sales.
However, fluctuation in currencies should be closely watched as well as shipping costs that could change
from time to time.

5. Other than variable marketing costs, other costs related to the manufacture of these 200 units have been
consumed. Therefore, any selling price above the differential costs would be automatically considered as
an income. Because the 200 units have to be sold through regular channels at reduced prices, the
differential cost per unit = variable marketing cost = $275 per unit. This price corresponds to the
break-even price just for those 200 units.

6. In-house cost (as computed in analysis section of this case) equals $2,444. The proposal of $2,475 per
unit should not be accepted since it would reduce total income when there is no outsourcing.

7. As we see in analysis for question 7 above, with outsourcing, the income would be $5,500,000 – pmt to
outsourcing co., while income without outsourcing is $2,550,000. Therefore, the very maximum payment
to outsourcing company should be: $5,500,000 - $2,550,000 = $2,950,000, or $2,950/unit
This time, the proposed price of $2,475/unit is acceptable since it is below the maximum acceptable
payment, which is $2,950.

D. What Learned?
This case provides opportunity to determine alternative decisions in order to maximize profits taking in
account costs and entity total capacity. Important approaches and terms are also emphasized: break-even
analysis, fixed costs, variable costs, overhead costs, target profit, unit contribution, differential income and
contribution percent.

E. References

Anthony, Hawkins and Merchant. 2007 . Accounting Text & Cases. 12th edition. McGraw-Hill Irwin.

Accounting Cost Behavior – Online Accounting Lecture/Tutorial: http://simplestudies.com/accounting-

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