Perry Medical Center (PMC) has five medical technicians who are responsible for conducting sonogram testing. Each technician is paid a salary of $36,000 and is capable of processing 1,000 tests per year. The sonogram equipment is one year old and was purchased for $150,000. It is expected to last five years. The equipment’s capacity is 25,000 tests over its life. Depreciation is computed on a straight-line basis, with no salvage value expected. The reading of the sonogram is verified by an outside physician whose fee is $10 per test. The technician’s report with the outside physician’s note of verification is sent to the referring physician. In addition to the salaries and equipment, PMC spends $10,000 for forms, paper, power, and other supplies needed to operate the equipment (assuming 5,000 tests are processed). When PMC purchased the equipment, it fully expected to perform 5,000 tests per year. In fact, during its first year of operation, 5,000 tests were run. However, a larger hospital has established a clinic in Perry and will siphon off some of PMC’s business. During the coming years, PMC is expected to run only 4,200 sonogram tests yearly. PMC has been charging $65 for the test—enough to cover the direct costs of the test plus an assignment of general overhead (e.g., depreciation on the hospital building, lighting and heating, and janitorial services).

At the beginning of the second year, an HMO from a neighboring community approached PMC and offered to send its clients to PMC for sonogram testing provided that the charge per test would be $35. The HMO estimates that it can provide about 500 patients per year. The HMO has indicated that the arrangement is temporary—for one year only. The HMO expects to have its own testing capabilities within one year.

Required:

1. Classify the resources associated with the sonogram activity into one of the following:

(1) committed resources or (2) flexible resources.

2. Calculate the activity rate for the sonogram testing activity. Break the activity rate into fixed and variable components. Now, classify each activity resource as relevant or irrelevant with respect to the following alternatives: (1) accept the HMO offer and (2) reject the HMO offer. Explain your reasoning.

3. Assume that PMC will accept the HMO offer if it reduces the hospital’s operating costs. Should the HMO offer be accepted?

4. Harry Birdwell, PMC’s hospital controller, argued against accepting the HMO’s offer. Instead, he argued that the hospital should be increasing the charge per test rather than accepting business that doesn’t even cover full costs. He also was concerned about local physician reaction if word got out that the HMO was receiving tests for $35. Discuss the merits of Harry’s position. Include in your discussion an assessment of the price increase that would be needed if the objective is to maintain total revenues from sonogram testing experienced in the first year of operation.

5. Elaine Day, PMC’s administrator, has been informed that one of the sonogram technicians is leaving for an opportunity at a larger hospital. She has met with the other technicians, and they have agreed to increase their hours to pick up the slack so that PMC won’t need to hire another technician. By working a couple hours extra every week, each remaining technician can perform 1,050 tests per year. They agreed to do this for an increase in salary of $2,000 per year. How does this outcome affect the analysis of the HMO offer?

6. Assuming that PMC wants to bring in the same revenues earned in the sonogram activity’s first year less the reduction in resource spending attributable to using only four technicians, how much must PMC charge for a sonogram test?