OBJECTIVES:  The 2010 Patient Protection and Affordable Care Act (ACA) and other recently enacted health policies attempt to improve the efficiency of hospitals through the use of “value based” payments. The purpose of this exploratory study is to explore the relationship between the cost and quality of hospital care delivered by the Medicare program. METHODS: This study utilized hospital demographics, Medicare payments, and hospital charge measures for 9 diagnosis related groups (DRGs) for acute myocardial infarction (AMI), pneumonia, and heart failure under the Medicare Inpatient Prospective Payment System (IPPS). The data came from a set of 3,007 acute care hospitals in the U.S. that accepts Medicare payments. We analyzed the distribution of hospital costs by applying principal components analysis (PCA) to the relative cost of care for these 9 DRGs. The cost analysis was combined with a previously validated measure of hospital quality for these hospitals through a correlation analysis. RESULTS: The distribution of hospital cost scores resembled a bimodal distribution of high and low cost hospitals with relatively few close to the mean. A small segment of hospitals were high-cost outliers. After matching cost scores with previously generated quality scores, the correlation coefficient for the cost and quality scores was 0.73 (95% CI: 0.72-0.75, P<0.0001). CONCLUSIONS: The results of this study suggest that higher cost hospitals also tend to deliver higher quality care. Additional analyses are required to validate and determine the validity of these results. This type of analysis can be used to set the optimal reimbursement level under the Medicare program and other value based health insurance reimbursement systems.