Case 26 Abstract Cooper laboratories is a major producer of medical equipment, drugs and is a leader in ultrasonic medical equipment Ten years ago, health insurers implemented a payment system based on what they think a specific medical service might cost Hence, Cooper is motivated to cut costs by reducing expenses, especially since it has been a topic for politicians and law makers The company is discussing pushing their ultrasonic machine SONICA as well as looking at three possible options As Is, Price Increase, and Expand Case Context SONICA Cooper Laboratorys Ultrasonic machine used in gallbladder surgery, cost $200,000 Reduces operation time by 5 min lowering the cost from $1200 to $200 40 machines are currently sold per year with no marketing expenses Sales will increase to 170 by year 3 only to hospitals that perform at least 100 operations per year Three Options As Is no increase in capacity or price change, yearly production 50 This will create excess demand 2 Price Increase no increase in capacity, yearly production 50 price would be increased, this option is limited to 5 price increase in year 1 Reduce excess demand by raising the price Potentially lose sales 3 Expand No change in price buy expand capacity to accommodate the expected growth in demand Six Month Expansion $7 5 million 7 cost of capital 26 tax rate capacity raised to 210 machines 7 year project life All equipment cost except 3 Machines 3 machines leased for $60,000 a year (8 payment lease with first due immediately) Straight line 5 year accumulated depreciation Marketing expenses for expansion Year 1 $860,000 Year 2 $265,000 Year 3 $90,000 OPERATION COST CONSIDERATIONS Year 1 VC per unit $125,000 Year 2 $118,000 Year 3 $115,000 economies of scale is presumed for each year after Maintenance Supervisory labor $310,000 Fixed Cost $245,000 Administrative Salaries $150,000 Computer value with 6 year life $400,000 with significant amount of excess capacity Reorganization will save Cooper $150,000 annually MARKETING CONCERNS Advertise heavily in trade journals Attend medical conventions Make quality brochures to give to sales reps If Cooper decides to expand Marketing Expenses Year 1 $860,000 Year 2 $265,000 Year 3 $ 90,000 2 The case discusses three options, but there is also a fourth, which is literally to do nothing that is, keep production at 40 machines a year a It is not really necessary to do a discounted cash flow analysis on the as is option to determine that it is superior to do nothing explain why b It is also not necessary to do a discounted cash flow analysis on the price increase alternative to see that it is superior to as is this implies, given part (a), that price increase is better than do nothing explain why c Given parts (a) and (b), what is the point of doing the NPVs in question 1 That is, can you see any advantage in calculating NPVs even though it seems obvious without this information that price increase is superior to both do nothing and as is Explain

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Case 26 Abstract Cooper laboratories is a major producer of medical equipment, drugs and is a leader in ultrasonic medical equipment. Ten years ago, health

Case 26 Abstract

Cooper laboratories is a major producer of medical equipment, drugs and is a leader in ultrasonic medical equipment. Ten years ago, health insurers implemented a payment system based on what they think a specific medical service might cost. Hence, Cooper is motivated to cut costs by reducing expenses, especially since it has been a topic for politicians and law-makers. The company is discussing pushing their ultrasonic machine SONICA as well as looking at three possible options; As Is, Price Increase, and Expand.

Case Context

SONICA

Cooper Laboratorys Ultrasonic machine used in gallbladder surgery, cost $200,000.
Reduces operation time by 5 min lowering the cost from $1200 to $200.
40 machines are currently sold per year with no marketing expenses.
Sales will increase to 170 by year 3 only to hospitals that perform at least 100 operations per year.

Three Options:

As Is no increase in capacity or price change, yearly production 50

This will create excess demand

2. Price Increase no increase in capacity, yearly production 50 price would be increased, this option is limited to 5% price increase in year 1

Reduce excess demand by raising the price. Potentially lose sales

3. Expand No change in price buy expand capacity to accommodate the expected growth in demand

Six-Month Expansion:

$7.5% million
7% cost of capital 26% tax-rate
capacity raised to 210 machines
7-year project life
- All equipment cost except 3 Machines

3 machines leased for $60,000 a year

(8 payment lease with first due immediately)

Straight-line 5-year accumulated depreciation

Marketing expenses for expansion:

Year 1 = $860,000

Year 2 = $265,000

Year 3 = $90,000

OPERATION COST CONSIDERATIONS

Year 1 - VC per unit = $125,000

Year 2 - = $118,000

Year 3 = $115,000 economies of scale is presumed for each year after

Maintenance & Supervisory labor = $310,000

Fixed-Cost = $245,000

Administrative Salaries = $150,000

Computer value with 6-year life = $400,000 with significant amount of excess capacity

Reorganization will save Cooper $150,000 annually

MARKETING CONCERNS

Advertise heavily in trade journals
Attend medical conventions
Make quality brochures to give to sales reps

If Cooper decides to expand:

Marketing Expenses: Year 1 = $860,000

Year 2 = $265,000

Year 3 = $ 90,000

2. The case discusses three options, but there is also a fourth, which is literally to do nothing; that is, keep production at 40 machines a year.

a. It is not really necessary to do a discounted cash flow analysis on the as is option to determine that it is superior to do nothing. explain why

b. It is also not necessary to do a discounted cash flow analysis on the price increase alternative to see that it is superior to as is. this implies, given part (a), that price increase is better than do nothing. explain why.

c. Given parts (a) and (b), what is the point of doing the NPVs in question 1? That is, can you see any advantage in calculating NPVs even though it seems obvious without this information that price increase is superior to both do nothing and as is? Explain.