Question

1. Watertown Health System, a for-profit provider, has fixed costs of $2 million. Variable patient service costs are $10 per visit, and variable administrative costs are $5 per visit. Watertown is planning to contract with a local HMO, which has proposed an annual capitation payment of $150 per member for its population of 20,000 members. Based on an analysis of historical claims data, the HMO estimates that a member utilizes an average of 2 visits per year. The income tax rate is 25%. Consider this scenario as the base case. a. Calculate the amount of pre-tax profit that Watertown would make under the base case. b. Calculate Watertown's accounting breakeven volume in number of visits. c. In a cost-volume-profit (CVP) analysis graph with the number of visits as the volume measure (on the x-axis), what would be the slope of the total costs line and the total revenues line? d. Calculate Watertown's accounting breakeven volume in number of members. e. In a CVP analysis graph with the number of members as the volume measure (on the x- axis), what would be the slope of the total costs line and the total revenues line? f. If Watertown wants to earn $375,000 in after-tax profit, what is their target level of per- member utilization of visits?

Answer 1

a. Pre-Tax Profit in Base Case - $400,000

A	Total Members	Given	20000
B	No. of visits per year	Given	2
C	Total Visits Per Year	A x B	40000
D	Capitation Payment Per Member	Given	$150
E	Annual Revenue Est.	Given	$3,000,000
F	Fixed Costs	Given	$2,000,000
G	Variable Costs Per Visit	G-1 + G-2	$15
G-1	Patient Service Cost Per Visit	Given	$10
G-2	Administrative Cost Per Visit	Given	$5
H	Total Variable Cost	G x C	$600,000
I	Total Pre-Tax Proft	E - F - H	$400,000

b. Break-even number of visits - 34,666 (rounded to whole number)

d. Break-even number of members - 17,333 (rounded to whole number)

J	Total Costs	F + H	$2,600,000
K	Break-even number of members	J / D	17,333
L	Break-even number of visits	K x 2 (avg. 2 visits per member)	34,666

c. & e. CVP

Slope of total revenues line = Contribution Margin

Slope of total cost line = Variable Cost

Point of intersection = Break-even point

CVP Graph - Visits 4500000 4000000 3500000 3000000 2500000 2000000 1500000 1000000 500000 10000 15000 20000 25000 30000 35000 40000 45000 50000 55000 Total Costs Fixed Costs - Variable costs - Total Sales -

CVP Graph - Members 3500000 3000000 2500000 2000000 1500000 1000000 500000 5000 7500 10000 12500 15000 17500 20000 Total Costs Fixed Costs — Variable Costs Total Sales

f. Number of visits for After-Tax Profit of $375,000 -- 41,667 visits (rounded to whole number)

A	Total After-Tax Profit	Given	$375,000
B	Tax %	Given	25%
C	Total Pre-Tax Proft	A / (1-B)	$500,000
D	Fixed Costs	Given	$2,000,000
E	Contribution Margin	C + D	$2,500,000
F	Capitation Payment Per Member	Given	$150
G	Capitation Payment Per Vist	F / 2	$75
H	Variable Costs Per Visit	H-1 + H-2	$15
H-1	Patient Service Cost Per Visit	Given	$10
H-2	Administrative Cost Per Visit	Given	$5
I	Contribution Per Visit	G - H	$60
J	Visits for required Contribution Margin	E / I	41,667