Question

Sabrina Hoffman is founder and CEO of Golden Care, Inc., which owns and operates several assisted-living facilities. The facilities are apartment-style buildings with 25 to 30 one- or two-bedroom apartments. While each apartment has its own complete kitchen, in every building Golden Care offers communal dining options and an on-site nurse who is available 24 hours a day. Residents can choose monthly meal options that include one or two meals per day in the dining room. Residents who require nursing services (e.g., blood pressure monitoring and injections) can receive those services from the nurse. However, Golden Care facilities are not nursing homes, all residents are ambulatory, and custodial care is not an option. In the five years it has been in operation, the company has expanded from one facility to five, located in southwestern cities. The income statement for last year follows.

Golden Care, Inc.
Income Statement for Last Year
Revenue		$2,880,000
Cost of services		2,016,000
Gross profit		$864,000
Marketing and administrative expenses		500,000
Operating income		$364,000

Sabrina originally got into the business because she had trouble finding adequate facilities for her mother. The concept worked well, and income over the past five years had grown nicely at 20 percent per year. However, Sabrina sensed clouds on the horizon. She knew that the population was aging and that her current clients would be moving to more traditional forms of nursing care. As a result, Sabrina wanted to consider adding one or more nursing homes to Golden Care. These nursing homes would be staffed around the clock with RNs and LPNs. The residents would likely have more severe medical problems and would be confined to beds or wheelchairs. Sabrina knew that quality care of this type was needed. So, she contacted Peter Verdon, her marketing manager, and Bernadette Masters, her accountant, for a brainstorming session.

Peter: "Sabrina, I really like the concept. As you know, several of our facilities have faced seeing their long-term residents move out to local nursing homes. Not only are these homes of lower quality than what we could provide, but losing a resident is heartrending for the staff, as well as for the remaining residents. I like the idea of providing a transition from less care to more."

Bernadette: "I agree with you, Peter. But let's not forget the differences between assisted-living and full-time, nursing-home-type care. Our expenses will really increase."

Sabrina: "That's why I wanted to talk with both of you. As you know, Golden Care's mission statement emphasizes the need to make a profit. We can't continue to serve our residents and provide high-quality care if we don't make enough money to pay our staff a living wage and earn enough of a profit to smooth over the rough patches and continue to improve our business. Could the two of you look into this idea, and get back to me in a week or so?"

Throughout the following week, the three communicated by e-mail. By the end of the week, a number of possibilities had surfaced, and these were summarized in a message from Bernadette to the others.

TO: [email protected], [email protected]

FROM: [email protected]

MESSAGE:

I've compiled the ideas from all of our e-mails into the following list. This may be a good starting point for our meeting tomorrow.

Buy an existing nursing home in one of Golden Care's current locations.

Buy an existing nursing home in another city.

Build a new nursing home facility in one of Golden Care's current locations.

Build a new nursing home facility in another city.

Build a wing on to an existing Golden Care facility. The Apache Junction facility has sufficient open land for an addition.

The next day, Sabrina, Peter, and Bernadette met again in Sabrina's office.

Sabrina: "I didn't realize there were so many possibilities. Are we going to have to work up numbers on each of them?"

Bernadette: "No, I think we can eliminate a few of them pretty quickly. For example, building a new facility would cost more than the other options, and it would involve the most risk."

Peter: "I agree, and I also think we might eliminate the purchase of an existing nursing home for the same reasons. Also, existing homes would not give us the option of building a facility that is state of the art and meets our needs, and it would lock us into a preexisting patient mix."

Sabrina: "I like that thinking. Let's restrict our attention to Option 5."

Bernadette: "I thought you might like that option, so Peter and I sketched out two alternatives for an extension of the Apache Junction building. We call the alternatives Basic Care and Lifestyle Care."

Peter: "There are different markets for each type of care. If we want to concentrate on Medicare and Medicaid patients, the reimbursement is lower, and we would want to offer the Basic Care option. Private insurance and private-pay patients could afford more services; if we are marketing to these patients, we could offer the Lifestyle Care option. Both alternatives provide high-quality nursing care. Basic Care concentrates on the quality nursing and maintenance activities. For example, the addition would have 25 double rooms, two nursing stations, two recreation rooms, a treatment room, and an office. The Lifestyle Care option adds physical and recreational therapy with a specially equipped gym and pool. That addition would have 30 single rooms, two nursing stations, a recreation room, a swimming pool, a hydrotherapy spa and gym, a treatment room, and an office. In each case, there would be cable TV and telephone hookups in each room and a buffer area between the nursing home and the apartments."

Sabrina: "Why the buffer area? Won't that add unnecessary cost?"

Peter: "It adds cost, but it will be well worth it. Sabrina, you must remember that the nursing home patients are different from the apartment residents. Some of the patients will have advanced dementia. We'll lose apartment residents in a hurry if they have to be reminded every day of what might be in store for them later on."

Sabrina: "I see your point. Bernadette, what will these two plans cost? I'll tell you right now that I like the Lifestyle Care option better. It fits with our history of doing whatever we can to make life better for our residents."

Bernadette: "I've checked into the costs of putting on a new wing and operating both alternatives. Here's a listing."

Basic Care				Lifestyle Care
Construction		$1,500,000		Construction		$2,000,000
Annual operating expenses:				Annual operating expenses:
Staff:				Staff:
RNs (3 × $30,000)		90,000		RNs (3 × $30,000)		90,000
LPNs (6 × $22,000)		132,000		LPNs (6 × $22,000)		132,000
Aides (6 × $20,000)		120,000		Aides (6 × $20,000)		120,000
Cooks (2 × $15,000)		30,000		Physical and recreational therapists (2 × $25,000)		50,000
Janitors (2 × $18,000)		36,000		Cooks (1.5 × $15,000)		22,500
Other* (60% variable)		300,000		Janitors (2 × $18,000)		36,000
Debt service		150,000		Other (60% variable)		360,000
Depreciation (over 20 years)		75,000		Debt service		200,000
				Depreciation (over 20 years)		100,000

* Other includes supplies, utilities, food, and so on.

"In both cases, total administrative costs for Golden Care would increase by $30,000 per year. This seems high, but the increased legal and insurance requirements will add significantly more paperwork and accounting."

Sabrina: "All this sounds reasonable, but why is reimbursement such an important factor?"

Peter: "Well, if you admit Medicaid patients, the state will reimburse at most $30,000 per year. Private insurance policies will pay roughly $46,000 per year. We can charge up to about $65,000 for private patients, but this type of care is so expensive that many of these patients exhaust their funds and go on Medicaid. The nice aspect of Medicaid is that we can be virtually assured that we will operate at capacity."

Sabrina: "Can we cross that bridge when we come to it?"

Peter: "No, not really. Once the patient is a resident of our facility, it is hard to evict him or her. Also, while it is legal to force patients out before they go on Medicaid and to refuse to accept Medicaid patients, once we do accept Medicaid patients, we are prevented by law from evicting them—no matter how high our costs go."

Sabrina: "OK, it looks as if we have some hard work ahead of us to decide whether or not to get into this line of business."

Required:

3a. Calculate the fixed and variable costs for each alternative. If an amount is zero, enter "0".

		Basic Care		Lifestyle Care
Fixed costs:
RNs		$		$
LPNs
Aides
Physical and recreational therapists
Cooks
Janitors
Other
Debt service
Depreciation
Administrative costs
Total fixed costs		$		$
Variable costs:
Other (at 60%)		$		$
Number of patients
Annual variable cost per patient		$		$

Answer 1

Calculation of fixed & variable cost of each alternative
	Basic Care	Lifestyle Care
Fixed Costs
RNs	$90,000	$90,000
LPNs	$1,32,000	$1,32,000
Aides	$1,20,000	$1,20,000
Physical & Recreational Therapists	$0	$50,000
Cooks	$30,000	$22,500
Janitors	$36,000	$36,000
Others	$1,20,000	$1,44,000
Debt Service	$1,50,000	$2,00,000
Depreciation	$75,000	$1,00,000
Administrative costs	$30,000	$30,000
Total fixed costs	$7,83,000	$9,24,500
Variable Costs
Others(at 60%)	$1,80,000	$2,16,000
Numbers of patients	50	30
Annual variable costs per patient	$3,600	$7,200