Question

On January 1, 2007, Mr. DMB purchased a new CT scan for the radiology department after evaluating cost and quality of CT scans from five vendors. The purchase price of the CT scan was $1 million dollars. The cost per procedure in technical and professional labor and supplies in $650 dollars.  

On February 1, 2007, one of the radiologists on staff informed Mr. DMB of a CT scan that would significantly decrease the cost per procedure to $325 per procedure. The purchase price of CT Scan # 2 is $1.1 million dollars.

1) What should Mr. DMB do? Should he purchase CT Scan # 2?

2) What additional information is needed to make a decision to purchase CT Scan # 2?

3) What could be done to avoid this situation, if at all?

4) Utilize the spreadsheet model to analyze changes in cost per procedure, revenue changes, and volume changes.

5) What suggestions would you provide Mr. DMB if a) he did purchase CT Scan # 2, b) he did NOT purchase CT Scan # 2?

Assume the volume is projected to cap at 5000 procedures.

	January 1, 2007 CT Scan # 1	February 1, 2007 CT Scan # 2
Initial Cost	($1,000,000)	($1,100,000)
Volume: # of Procedures	5000	5000
Cost per Procedure	$650	$325
Total Variable Cost	$3,250,000	$1,625,000
Net Revenue per Procedure	$1,000	$1,000
Net Revenue	$5,000,000	$5,000,000
Net Profit without Fixed Cost	$1,750,000	$3,375,000
Add Back Initial Cost	($1,000,000)	($1,100,000)
Profit	$750,000	$2,275,000

Please provide an explanation for the answer as I would like to understand how to solve the problem.

Answer 1

1)  Mr DMB should purchase the CT Scan 2 because it is resulting in increased profit.

2) The information regarding the life of the machines and cost of capital is required to take the decision.

3) The machine can be manufactured inhouse as well to avoid the decision of selection of vendors.

4)

Increase in Cost Per Procedure
		Janaury 1, 2007		February 1, 2007
		CT Scan # 1		CT Scan # 2
Initial Cost		($1,000,000)		($1,100,000)
Volume: # of procedures		5000		5000
cost per procedure		$700		$375
Total Variable Cost		$3,500,000		$1,875,000
Net Revenue per procedure		$1,000		$1,000
Net Revenue		$5,000,000		$5,000,000
Net profit without fixed cost		$1,500,000		$3,125,000
Add Back Initial Cost		($1,000,000)		($1,100,000)
Profit		$500,000		$2,025,000
Mr DMB should purchase the CT Scan 2 because it is resulting in increased profit.
	Decrease in Revenue per procedure
		Janaury 1, 2007		February 1, 2007
		CT Scan # 1		CT Scan # 2
Initial Cost		($1,000,000)		($1,100,000)
Volume: # of procedures		5000		5000
cost per procedure		$650		$325
Total Variable Cost		$3,250,000		$1,625,000
Net Revenue per procedure		$800		$800
Net Revenue		$4,000,000		$4,000,000
Net profit without fixed cost		$750,000		$2,375,000
Add Back Initial Cost		($1,000,000)		($1,100,000)
Profit		($250,000)		$1,275,000
Mr DMB should purchase the CT Scan 2 because it is resulting in increased profit.
	Decrease in Revenue per procedure
		Janaury 1, 2007		February 1, 2007
		CT Scan # 1		CT Scan # 2
Initial Cost		($1,000,000)		($1,100,000)
Volume: # of procedures		6000		6000
cost per procedure		$650		$325
Total Variable Cost		$3,900,000		$1,950,000
Net Revenue per procedure		$800		$800
Net Revenue		$4,800,000		$4,800,000
Net profit without fixed cost		$900,000		$2,850,000
Add Back Initial Cost		($1,000,000)		($1,100,000)
Profit		($100,000)		$1,750,000
Mr DMB should purchase the CT Scan 2 because it is resulting in increased profit.

5) a) Mr DMB should try to increase its volume because now the variable cost is reduced and he should try to take benefit from the opportunity by selling more.

b) In case the machine is not purchased, Mr DMB should try to decrease the variable cost so as to increase the overall profits.