Resource Usage, Special Order

St. Johns Medical Center (SJMC) has five medical technicians who are responsible for conducting cardiac catheterization testing in SJMCs Cath Lab. Each technician is paid a salary of $36,000 and is capable of conducting 1,000 procedures per year. The cardiac catheterization equipment is one year old and was purchased for $250,000. It is expected to last five years. The equipments capacity is 25,000 procedures over its life. Depreciation is computed on a straight-line basis, with no salvage value expected. The reading of the catheterization results is conducted by an outside physician whose fee is $120 per test. The technicians report with the outside physicians note of results is sent to the referring physician. In addition to the salaries and equipment, SJMC spends $50,000 for supplies and other costs needed to operate the equipment (assuming 5,000 procedures are conducted). When SJMC purchased the equipment, it fully expected to perform 5,000 procedures per year. In fact, during its first year of operation, 5,000 procedures were run. However, a larger hospital has established a clinic in the city and will siphon off some of SJMCs business. During the coming years, SJMC expects to run only 4,200 cath procedures yearly. SJMC has been charging $850 for the procedureenough to cover the direct costs of the procedure 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 SJMC and offered to send its clients to SJMC for cardiac catheterization provided that the charge per procedure would be $550. The HMO estimates that it can provide about 500 patients per year. The HMO has indicated that the arrangement is temporaryfor one year only. The HMO expects to have its own testing capabilities within one year.

3. Assume that SJMC will accept the HMO offer if it reduces the hospitals operating costs. Should the HMO offer be accepted?

4. Jerold Bossernan, SJMCs hospital controller, argued against accepting the HMOs offer. Instead, he argued that the hospital should be increasing the charge procedure rather than accepting business that doesnt even cover full costs. He also was concerned about local physician reaction if word got out that the HMO was receiving procedures for $550. Discuss the merits of Jerolds position. Include in your discussion an assessment of the price increase that would be needed if the objective is to maintain total revenues from cardiac catheterizations experienced in the first year of operation.