Finance management

CASE STUDY 5: THE ARRAY MACHINE

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An equipment acquisition proposal was being considered by a large hospital laboratory. TheAr- ray machine would enable the hospital to perform autoimmunity tests (for immunoglobulins IgG, IgM, and IgA, and complements C3 and C4) in-house rather than sending them to a reference laboratory. As a result, test turnaround time would be decreased by 2 days. The machine costs $50;000, with- a usefullife of 5 years. The depreciation schedule would be $10,000 per year.

The hospital's volume for the five autoimmunity tests is one of each test per day. Having the tests done by the reference laboratory costs the hospital an average of $10 per test. The hospital's average charge to patients is $20 per test. If the Array machine were, acquired and the autoim- munity tests done in-house, the costs of reagents used would average $2 per test .

.The Array machine can run a maximum of 40 patient samples and perform 20 different tests on each sample every 2 hours. Except in extraordinary circumstances, tests would be run Monday through Saturday.

The machine requires approximately 1 hour of technician time (valued at $15Ihour) each day to calibrate it, to conduct a test run for control purposes, and to perform general maintenance . This is a fixed cost since it does not vary by volume. Technician set-up time to run tests is negli- gible. Beyond the five autoimmunity tests-the lab wants to perform inhouse, the machine can also perform apolipoprotein cardiac profiles that are currently done on equipment in the clinical chem- istry department. The Array machine can provide a quantitative measure and not just the positive or negative indicator that the clinical chemistry departnient's current equipment gives.

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n-*<:stions 1. How many autoimmunity tests per year will have to be performed on the Array machine to

break even? .-,2. Given present volume, would there be an annual net contribution and, if so, how much? .

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Quantitative Techniques for Planning and Decision Making

BREAK-EVEN ANALYSIS Ii>

"What do we have to do to break even?" is asked frequently in business. Managers often find the answer through break-even analysis, a method of determining the relationship between total costs and total revenues at vari- ous levels of production or sales activity. Managers use break-even analysis because-before adding new products, equipment, or human resources- they want to be sure that the changes will payoff. Break-even analysis tells managers the point at which it is profitable to go ahead with a new venture. You will recall that the chapter opener focused on how important costs are to Dell Inc. The accompanying Management in Action illustrates how another famous company agonizes over costs in order to be profitable.

Exhibit 7-7 illustrates a typical break-even chart. It deals with a proposal to add a new product to an existing line. The point at which the Total Costs line and the Revenue line intersect is the break-even point. Sales shown to the right of the break-even point represent profit. Sales to the left of this point represent a loss.

Break-even Formula The break-even point (BE) is the situation in which total revenues equal fixed costs plus variable costs. It can be calculated with the following standard formula:

BE = FC p : VC

where P = selling price per unit

VC = variable cost per unit, the cost that varies with the amount produced FC = fixed cost, the cost that remains constant no matter how many units

are produced

Revenues and Costs ($ in thousands)

800

Revenue

CHAPTER 7

&_--- Describe how to use break-even analysis and decision trees for problem solving and decision making. -

700

Sales (in units)

break-even analysis A method of determining the relationship between total costs and total revenues at various levels a/production or sales activity.

Exhibit 7-7 Break·even Chart for Adding a New Product to an Existing Line A break-even chart indicates at what point a venture becomes profitable.

500

Break-Even

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Total Costs

600

Variable Costs

~ ~ 300~--------~~----------~------~-------- FixedCosts

200

100

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