Question

Janet Gilbert is director of a lab. She has some extra capacity and has contracted with some small neighboring hospitals to run some of their lab tests. She has recently had a study conducted and has determined that her costs for these contracts are $50,000, of which $7,000 is the variable cost of supplies. The rest is non-avoidable fixed cost. She currently charges an average of $30 per test. She is thinking of lowering her price by 20 percent in hopes of raising her current volume of 20,000 tests by 25 percent. If she does so, she expects her variable cost per test will go up by 5 percent. Determine the current and predicted (a) revenues, (b) variable costs, and (c) total contribution margin and product margin. What should she be recommended to do? Why? Show all calculations and provide recommendations for Ms. Gilbert.

Answer 1

Answer :

Below is the Table showing Current Revenue , Variable Cost , Total Contribution Margin and Profit Margin

	Working	Amount
Revenue	20000 * 30	600,000
Variable Cost	20000 * 0.35 (Refer Note)	7000
Contribution Margin	Revenue - Variable Cost	593,000
Fixed Cost	(Unavoidable)[50000 - 7000]	43000
Product Margin	Contribution Margin - Fixed Cost	550,000

Note : Per unit Variable Cost = 7000 / 20000 = 0.35

Below is the Table showing Predicted Revenue , Variable Cost , Total Contribution Margin and Profit Margin

	Working	Amount
Revenue	[20000 + (20000 * 25%)] * [30 - (30*20%)]	600,000
Variable Cost	[20000 + (20000 * 25%)] * [0.35 + (0.35*5%)	9187.5
Contribution Margin	Revenue - Variable Cost	590812.5
Fixed Cost	Assuming Unavoidable Fixed cost will remain same	43000
Product Margin	Contribution Margin - Fixed Cost	547812.5

As per the table on Current and Forecasted Figures , The amount of sales remains same under current as well as Predicted situation . But due to increase in Variable cost this is leading only to the increase in cost and no increse in Contribution Margin at all . Therefore Ms. Gilbert should continue with the current policy only. It's better not to decrease the rate .