Fargo Memorial Hospital has annual net patient service revenues of $14.4 million

Question

Fargo Memorial Hospital has annual net patient service revenues of $14.4 million. The hospital's patient accounts manager estimates that 10 percent of third party payers pay on Day 30, 60 percent pay on Day 60, and 30 percent pay on Day 90. a. What is Fargo's average collection period? (Assume 360 days per year throughout this problem.) b. What is the firm's current receivables balance? c. What would be the firm's new receivables balance if a newly proposed electronic claims system resulted in collecting from third-party payers in 45 and 75 days, instead of in 60 and 90 days? d. Suppose the firm's annual cost of carrying receivables was 10 percent. If the electronic claims system costs $30,000 a year to lease and operate, should it be adopted? (Assume that the entire receivables balance has to be financed.)

Explanation / Answer

(a). Fargo's average collection period = 66 days

Explanation;

Average collection period = (0.10 * 30) + (0.60 * 60) + (0.30 * 90)

Average collection period = (3 days) + (36 days) + (27 days) = 66 days

(b). Firm's current receivables balance = 2.64 million OR $2640000

Explanation;

Firm's current receivables balance = ($14.4 million * 66 / 360) = 2.64 million OR $2640000

(C). Firm's new receivables balance = $2.10 million OR $2100000

Explanation;

First of all let’s calculate new average collection period;

Average collection period = (0.10 * 30) + (0.60 * 45) + (0.30 * 75)

Average collection period = (3 days) + (27 days) + (22.5 days) = 52.5 days

Now’ let’s calculate firm's new receivables balance;

Firm's new receivables balance = ($14.4 million * 52.50 / 360) = $2.10 million OR $2100000

(d).

Yes, electronic claims system should be adopted because it will result into cost savings.

Explanation;

First of all let’s calculate carrying cost of receivables;

Carrying cost of receivables ($2100000 * 0.10) = $210000

Current carrying cost of receivables ($2640000 * 0.10) = $264000

Now, let’s calculate cost savings;

$264000 – $210000 – $30000 = $24000

Hence electronic claims system should be adopted.

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