HCM 565 Module 8 Portfolio Project Part 2 Mini Case C 102583

Hcm565module 8 Portfolio Project Part 2mini Case Chapter 8lewis Healt

HCM565 Module 8 Portfolio Project, Part 2 Mini Case Chapter 8 Lewis Health System Inc. has decided to acquire a new electronic health record system for its Richmond hospital. The system receives clinical data and other patient information from nursing units and other patient care areas, then either displays the information on a screen or stores it for later retrieval by physicians. The system also permits patients to call up their health record on Lewis's website. The equipment costs $1,000,000, and, if it were purchased, Lewis could obtain a term loan for the full purchase price at a 10 percent interest rate. Although the equipment has a six-year useful life, it is classified as a special-purpose computer, so it falls into the MACRS three-year class.

If the system were purchased, a four-year maintenance contract could be obtained at a cost of $20,000 per year, payable at the beginning of each year. The equipment would be sold after four years, and the best estimate of its residual value at that time is $200,000. However, since real-time display system technology is changing rapidly, the actual residual value is uncertain. As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Lewis that Consolidated Leasing would be willing to write a four-year guideline lease on the equipment, including maintenance, for payments of $260,000 at the beginning of each year. Lewis's marginal federal-plus-state tax rate is 40 percent.

You have been asked to analyze the lease-versus-purchase decision, and in the process to answer the following questions: a. What is the present value cost of owning the equipment? b. What is the present value cost of leasing the equipment? c. What is the net advantage to leasing (NAL)? d. Answer these questions one at a time to see the effect of the change on NAL.

Paper For Above instruction

The decision between leasing and purchasing medical technology equipment is a significant financial consideration for healthcare organizations. In the case of Lewis Health System’s potential acquisition of an electronic health record (EHR) system, a comprehensive financial analysis incorporating present value (PV) calculations enables informed decision-making. This paper examines the PV costs associated with both options, evaluates the net advantage of leasing over buying, and analyzes the impact of various financial modifications on this decision.

Calculating the Present Value Cost of Owning the Equipment

The upfront purchase price of the EHR system is $1,000,000. Assuming Lewis cannot pay cash directly, they would finance the full amount via a loan at a 10% interest rate, with an amortization schedule over six years, aligning with the equipment’s useful life. The company can depreciate the asset using MACRS 3-year class depreciation, which provides accelerated deductions, reducing taxable income faster. The depreciation schedule significantly affects the PV tax shield, which is a key component of the PV cost analysis.

The annual maintenance cost is $20,000 payable at the beginning of each year for four years. Operating costs impact the total cost of ownership and should be discounted to present value at the company’s cost of capital—in this case, 10%. Additionally, the residual value after four years is estimated at $200,000, but due to rapid technological changes, there exists uncertainty. For PV calculation, assuming the residual value is certain, we discount it back to PV using the 10% rate.

Using these parameters, the PV of the initial purchase is straightforward, given it's an immediate outlay of $1,000,000. The loan interest and depreciation tax shield further influence the PV calculation. The tax shield is calculated by multiplying depreciation deductions by the tax rate, which reduces the actual cost of the equipment over its life. The MACRS depreciation schedule for a 3-year class asset allows for accelerated depreciation, resulting in higher deductions in the initial years, thereby increasing the PV of tax savings.

Calculating the Present Value of Leasing

Alternatively, leasing involves annual payments of $260,000 at the beginning of each year over four years. These lease payments are tax-deductible expenses, thus lowering taxable income. The PV of lease costs is calculated by discounting each of these payments at the company's cost of capital, 10%, considering that payments are made at the start of each period. The total PV of lease payments then becomes the PV cost of leasing.

Lease agreements often include maintenance, which simplifies costs as the lessor incorporates maintenance into the lease payment, positioning the lease as an operating expense. The tax shield benefits due to deductible lease payments can be factored into this analysis, reducing the effective lease cost.

Evaluating Net Advantage to Leasing (NAL)

The NAL is calculated as the difference between the PV of owning and leasing. A positive NAL indicates a preference for leasing, while a negative value favors purchasing. This differential incorporates initial costs, ongoing costs, tax shields, residual value, and financing considerations. By comparing the two PV structures, organizations like Lewis Health System can determine the most economically advantageous option.

Impact of Financial Changes on NAL

Altering key financial variables influences the NAL and, consequently, the attractiveness of leasing versus owning. For instance, increasing the interest rate to 12% raises the discount rate, decreasing the PV of future costs and residuals, and potentially making leasing more attractive. Conversely, reducing the tax rate to 34% diminishes the value of tax shields, potentially favoring outright purchase.

Increases in maintenance costs from $20,000 to $25,000 per year elevate the PV of ownership costs, possibly making leasing more attractive. A decrease in residual value to $150,000 lowers the potential salvage benefit, increasing the relative cost of ownership. An increase in system price to $1,050,000 directly raises the initial purchase cost, impacting the PV of owning negatively.

Each of these financial adjustments impacts the PV calculations and, ultimately, the NAL. Organizations must thoroughly analyze these sensitivities to make well-informed decisions aligned with their financial health and strategic goals.

Conclusion

Deciding between leasing and purchasing medical equipment involves calculating the PV of associated costs, tax benefits, and residual values. The choice depends on the organization’s financial parameters, risk tolerance, and strategic objectives. Sensitivity analysis demonstrates that changes in interest rates, tax rates, maintenance costs, residual values, and purchase prices significantly influence the decision. Healthcare organizations should employ detailed PV analyses, as illustrated for Lewis Health System, to optimize their capital allocation effectively.

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