Easton Diagnostics is a large medical testing laboratory that services a four- county region. Easton runs a van that picks up specimens from clinics and hospitals and takes them to the Easton laboratory where various tests are conducted. Easton currently has a large chemical blood analysis system. This system runs a battery of standard tests for which Easton is reimbursed $ 750 per blood sample. The cost structure of the current blood analysis system consists of annual fixed costs ( lease payment of $ 1.6 million, supervisory costs of $ 400,000, and occupancy costs of $ 100,000) and variable costs per blood sample ( direct labor, including transporting the blood samples, technicians, and so forth of $ 175, direct materials of $ 125, and a royalty fee of $ 150).
A competing vendor has approached Easton Diagnostics with a comparable system that per-forms the same set of tests. The reliability and quality of both the proposed and the existing systems are the same. The competing vendor is willing to lower the annual lease payment to $ 1.2 million but raise the royalty fee by $ 30 per blood sample to $ 180. Both the existing and proposed leases have the same contractual terms in all other respects. If Easton adopts the competing vendor’s proposal, the current fee it charges ($ 750) and the direct labor costs per blood sample ($ 175) are unaffected. However, the proposed equipment adds $ 10 per blood sample analyzed to direct materials.
a. How does Easton Diagnostic’s break- even point for standard blood tests change if the competing vendor’s proposal is accepted?
b. Easton Diagnostic currently analyzes 10,300 blood samples per year, and this number has remained constant over the past few years. Moreover, Easton management does not foresee any growth in the number of standard blood tests it performs. Make a recommendation to management as to whether Easton should stay with its existing blood analysis equipment or accept the competing vendor’s proposal. Justify your recommendation. (Assume that there are no cancellation payments on the existing equipment and there are no costs of converting from the existing equipment to the new equipment other than the costs described in the problem.)