Three years ago Medical Dynamics, a medical equipment unit of Johnson and Sons, Inc., initiated the manufacture and sales of a portable sterilization unit (Quik-Sterz) that can be placed in the hospital room of a patient. This unit sterilizes and makes available at the bedside some of the reusable instruments that nurses and doctors usually obtain by walking to or receiving delivery from a centralized area. This new unit makes the instruments available at the point and time of use for burn and severe wound patients who are in a regular patient room. There are two models of Quik-Sterz sold. The standard version sells for $10.75, and a premium version with customized trays and a battery backup system sells for $29.75. The product has sold well to hospitals, convalescent units, and nursing homes at the level of about 1 million units per year.

1. Use traditional indirect cost allocation to verify Arnie’s cost and price estimates.

2. Use the ABC method to estimate the indirect cost allocation and total cost for each model.

3. If the prices and number of units sold are the same next year (750,000 standard and 250,000 premium), and all other costs remain constant, compare the profit from Quik-Sterz under the ABC method with the profit using the traditional indirect cost allocation method.

4. What prices should Medical Dynamics charge next year based on the ABC method and a 10% markup over cost? What is the total profit from Quik-Sterz predicted to be if sales hold steady?

5. Using the results above, comment on the production manager’s prediction of indirect costs using ABC (1/3 standard; 2/3 premium) and the two reasons given to not produce the premium version of Quik-Sterz.