Cost allocation, downward demand spiral. Meals To Go operates a chain of 10 hospitals in the Los Angeles area. Its central food-catering facility, Mealman, prepares and delivers meals to the hospitals. It has the capacity to deliver up to 1,460,000 meals a year. In 2017, based on estimates from each hospital controller, Mealman budgeted for 1,050,000 meals a year. Budgeted fixed costs in 2017 were $1,533,000. Each hospital was charged $6.16 per meal—$4.70 variable costs plus $1.46 allocated budgeted fixed cost.
Recently, the hospitals have been complaining about the quality of Mealman’s meals and their rising costs. In mid-2017, Meals To Go’s president announces that all Meals To Go hospitals and support facilities will be run as profit centers. Hospitals will be free to purchase quality-certified services from outside the system. Dean Wright, Mealman’s controller, is preparing the 2018 budget. He hears that three hospitals have decided to use outside suppliers for their meals, which will reduce the 2018 estimated demand to 912,500 meals. No change in variable cost per meal or total fixed costs is expected in 2018.

Required

1. How did Wright calculate the budgeted fixed cost per meal of $1.46 in 2017?

2. Using the same approach to calculating budgeted fixed cost per meal and pricing as in 2017, how much would hospitals be charged for each Mealman meal in 2018? What would the reaction of the hospital controllers be to the price?

3. Suggest an alternative cost-based price per meal that Wright might propose and that might be more acceptable to the hospitals. What can Mealman and Wright do to make this price profitable in the long run?