Marginal Analysis: Short-Term Versus Long-Term Implications
Posted on June 8, 2009 - Filed Under Finance
The Atlanta/Peachtree illustration points out how the contribution margin can be used in managerial decision making. To help see this, the analysis needs to be viewed from a different perspective. Suppose the clinic is forecasting a volume of 50,000 visits for 2005, and Peachtree HMO offers to provide the
clinic 25,000 additional visits at $60 revenue per visit. These 25,000 visits are called marginal, or incremental, visits, because they add to the exiting base of visits. Should the clinic’s managers accept this offer?
Although each marginal visit from the contract brings in only $60 compared with $100 on the clinic’s other contracts, the marginal cost, which is the cost associated with each additional visit, is the variable cost rate of $28.18. The clinic’s $4,967,462 in fixed costs will be incurred whether the offer is accepted or rejected, so these costs are not relevant to the decision. In finance parlance, the clinic’s fixed costs are nonincremental to the decision. Because the contribution margin of each visit at the margin (the marginal
contribution margin) is a positive $31.82, each visit contributes positively to Atlanta’s recovery of fixed costs and ultimately to profits. Thus, the offer should be accepted or at least seriously considered.
Taken From : HEALTHCARE FINANCE
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