The administrator of ABC Hospital, Mr. Stevens, has just received the latest fin

Question

The administrator of ABC Hospital, Mr. Stevens, has just received the latest financial report, and the news is not good. The hospital has been losing money for over a year, and if things don't improve, it may lose its AA bond rating. Stevens has met with his vice president of finance, Mr. Sanger, and as asked him to identify areas for cutting costs, beginning with services that are operating at a loss. The following information is for services provided at ABC Hospital's ambulatory care clinic.

Annual volume (in patient visits) = $7,000

Care per visit = $155

Variable cost per visit = $45

Fixed costs = $700,000

1) Suppose that all fixed costs are avoidable. What should Sanger recommend to Stevens regarding dropping the clinic? 2) What if only $300,000 of the fixed costs were avoidable? Would this change his recommendation? 3) Are there any other considerations that should be taken into account when making this decision?

Explanation / Answer

(1) steven should not choose to drop the clinic, if all fixed costs are avoidable. Steven should continue his clinic profession:

revenue(7000*$155) $1085000

Less: variabel cost(7000 * $45) $315000

profit $770000

There is a increase in profit by =($770000 - $70000)

= $700000

Note:- profit if fixed cost is not avoidable:

revenue(7000*$155) $1085000

Less: variabel cost(7000 * $45) $315000

   less: fixed cost $700000

profit $70000

2)    if only $300,000 of the fixed costs were avoidable, then he should still continue his clinic , because still he has a profit of ( $370000 - $70000) = $300000 more

revenue(7000*$155) $1085000

Less: variabel cost(7000 * $45)    $315000

   less: fixed cost   $400000

profit $370000

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