Case

Moreover, Green Valley had issued mini copal revenue bonds on several occasions to finance large expansions and improvements. The key elements of Green Valleys strategy is that administration and s revive department did not take part in the capital budgeting process. Since Green Valley Medical Center was a Nippon refit hospital established with a federal grant, and grown with continuous support from state revenues, the board of t rustles and of the previous SCOFF was prefer to invest in medical equipment.

As the Director of Cardiology mention deed in case material that doctors have got tradition, numbers and the hospital’s mission. They were closest to the needs of the hospital and of the patients. Those doctors could bring more benefits to hospital, such as increasing the vow lumen of business directly, being helpful in the hospital rating and reputation. The better medical equipment c loud bring more patients and revenue, so the Medical Center could get more grant and state revenues to invest more ca petals. Besides, Green Valley Medical Center was a teaching hospital specialize in cardiology, oncology, and neurology guy.

Hospital was widely regarded for the innovative work and research conducted by its medical community, so do torso had to invest in medical equipment or operating expense to continue their researches. 2. Why does the existing capital budgeting system need to be changed? A. Provide a short summary of how the existing capital budgeting system word KS. The current capital budgeting system is a priority assessment. First, India Vidalia submitted requests to their department head if the costing was $1 ,OHO or more, classified as new and repel cement equipment costs, and under $1 ,OHO costs were classified as operating expense.

Second, each department head ranked all requests referred to the reference from last year, and deleted unnecessary requests. Third, the ho capital’s fiscal affairs department combined and prioritize along with the requests of all departments to form one master list after receiving the list and Equipment Request Form from each department head. Finally, the Board of T rustles reviewed and approved the master list at their November meeting. B. What are the flaws to this system and the potential consequences of contain nuking with the existing capital budgeting system? The biggest flaw of existing capital budgeting system is rarely as objective e.

Although the financial uniqueness of capital requests were taken into consideration, the financial data presented by the departments is unreliable and often unfounded. In the decision making process, medical deep retreat produced resistance continuously. Due to the lack of objective, the capital budgeting system was n to aligned with the hospitals best longer interests. There was an unwritten policy that medical equipment ha d priority. However, there was no financial formula could support this unfair phenomenon. If the required med kcal equipment cannot add value to the Medical Center, the Board of Trustees should reject it.

If the request of admit estimative support can largely reduce the cost expense and improve the work efficiency, the Board of Trustees should a accept it. Lacking of reliable financial data, even though the available funds for hospital capital purchases had grow n at a rate of 10 to 15 percent every year, the financial director could not make reasonable and strategically decision n since how the money was distributed was not clear. Moreover, the requests were classified by cost groupings, not by priority. The potential consequences is that some important requests might be ignored by the Boar of Trustees since the cost is not expensive. . How do you think the two projects will fair under Mr.. Kelvin’s new capital buy getting technique? A. Calculate each project’s net present value (NP) I. What is the right discount rate to use? [Worksheet 1: Discount rate] Using WAC formula: E = market value of the firm’s equity, D = market value of the firm’s debt, Re cost of equity, Rd = cost of debt, Etc -corporate tax rate, E/ (E+D) = percentage of financing that is equity, D/ (E+D) = percentage of financing that is debt. Assume corporate tax rate is 0%, and the cost of equity is as Mr.. SKI nine believed.

According to the calculation of WAC, the appropriate discount rate is 8. 1 1%. Ii. How does varying the discount rate change the NP of each project? [Worksheet 2: NP] According to the Worksheet 2, the NP of the laundry proposal is $1 ,075 ,064. 87, higher than the PET proposal which is $124,621. 24. The data suggests that the laundry proposal will add VA lee to the Green Valley Medical Center and benefit Medical Center shareholders since the NP is positive, but the PEE T project will lose value to the Green Valley Medical Center. The relationship between discount rate and NP is negative.

As the disc unto rate decreasing, the NP of each project increase, vice versa. B. Calculate the internal rate of return (AIR) [Worksheet 3:ERR] Internal rates of return, as the rate of growth a project is expected to GE narrate, are used to evaluate the desirability of investments. Higher AIR, the more desirable it is to undertake t he project. According to the Worksheet 3, the laundry proposal has higher AIR (7. 63%) than the PET propos Gal’s AIR (23. 02%). The data indicates that assuming all other factors are equal among those two proposals, the luau Andy project would probably be considered the best and undertaken first. . Suppose that for the PET project, Of the 1600 clinical scans are reimburse seed, and for the Laundry investment, the savings end after 1 0 years. How do the projects compare? [worksheet 2: NP] & worksheet roll] The NP of the PET project is $1,691 ,499. 96, and the NP of the laundry project is $624,198. 30. Both projects add value to the Medical Center now, and the PET project adds more. The AIR of the PET project is 14. 23%, and the AIR of the laundry project is 20. 30%. Comparing to the original assumption, the e laundry proposal has higher AIR in both assumptions, but the NP in these two assumptions is different.

Therefore, Mr.. Klein should choose the laundry project if he ranks prone acts by their overall rates of return rather than their net present values. D. What can you say about the sensitivity of each investment to the assumption The PET project is highly sensitive to the reimbursed rate. As reimburse d rate of the 1600 clinical scans changing from 50% to 60%, the net present value changes from negative to p costive which means that this project changes from losing value to the hospital to adding value to the hospital. Bess des, the internal rates of return increase from 7. 63% to 14. 23%.

At the first assumption, the AIR is lower than the required rate of return 8. 11%, so the PET project should be rejected. However, after increasing reimbursed rate, the e AIR is higher than the required rate of return. Therefore, the PET project is sensitivity. On the other hand, the laundry proposal is insensitivity. As time period changing from 15 to 10 years, the NP decreases nearly 40% from $1 to $624,198, and the AIR decreases on Ii 3% from 23. 02% to 20. 30%. Assuming only one project can be accepted, which one should it be? Which one do you think will be accepted? If only one project can be accepted, Mr..

Klein should choose the laundry y proposal. According to the data calculated above, the laundry proposal has positive NP so it will add value to the Green Valley Medical Center, and AIR of laundry’ proposal is much greater than the required rate of return. The PET project has ambiguous NP and AIR due to the sensitivity of the assumptions. Fifth reimbursed rate is highly enough to make NP positive and AIR higher than the required rate of return, the PET project could be the other opt ion for the Board of Trustees taking into consideration. In my personal opinion, I am still prefer to the laundry project.