Assume the following information about projected cost and charges for a hospital

ID: 2713821 • Letter: A

Question

Assume the following information about projected cost and charges for a hospital in 2016: Fixed Costs = $10,000,000 Variable Cost per Inpatient Day = $200 Charge per Inpatient Day = $1,000. Initial Volume of 15,000 Inpatient Days

Back to the base case. Now assume this hospital has a sole payer, an HMO, which proposes an annual capitation payment of $200 for each of its 75,000 members for the inpatient stays. Past experience indicates the population served will average 0.2 inpatient days per year. What will be the total revenue on this contract? What will be the expected annual inpatient days? Construct the hospitals P&L statement on this contract. What is the hospital’s break-even point (volume) on this contract? Show your work. Interpret the result. (Suppose you need to explain to a health services manager) Yes or No. Will the hospital get profit if it operates in a volume higher than this break-even point?

Explanation / Answer

Projected Costs Chargeable in 2016

Fixed costs = $ 10,000,000

Variable costs per Inpatient Days = $200

Charge per Inpatient Day = $ 1000

Initial Volume = 15000 in patient days

Contract Proposed by HMO

Annual Capitation Payment = $ 200

Total Number members in HMO = 75000

Average Inpatient days = 0.2 per annum

Expected annual Inpatient Days = 75000 * 0.2 = 15,000

Total Revenue = 75000 * $200 = $ 15,000,000

Let X be the number of in-patient days required to make the hospital break-even. That is the total of variable costs and fixed costs equal zero. Then

$1000 * X - $ 200 * X - $ 10,000,000 = 0

$ 800 * X = $ 10,000,000

X = $ 10,000,000 / $ 800 = 12500 inpatient days

Hospital break-even point = 12500 inpatient days

The hospital gets an operating profit if it operates above the break-even point. The net profit may or may not happen depending on the levels of non-operating expenditure.

P&L Statement for the contract

Total Revenue from HMO

75000 * $ 200

$ 15,000,000

Total Variable Costs

75000 * 0.2 * $ 200

$ 3,000,000

Total Fixed Costs

$ 10,000,000

Operating Profit

Revenue – VC - FC

$ 2,000,000

As the above profit from the contract is same as that projected by the hospital, the contract is acceptable.