Question

1. Benefit-cost Analysis

Park Crest Hospital is looking into the possibility of upgrading its patient tracking information system. The current system is a management information system (MIS) that maintains records on the active status of patients residing in the hospital at a given moment. It ties into patient medical treatment files and financial history files. Thus it is possible to determine the current disposition of patients residing in the hospital (e.g., room number, telephone number, attending physicians, attending nurses, etc.); to access facts about the patient’s prior medical history; and to access financial data on current and past charges made to the patient.

The current MIS is more than seven years old. In view of changes in information storage and retrieval technology that have recently occurred, as well as the current system’s inability to deal with changes that have been made to handle the patient medical treatment files, Park Crest management has decided to upgrade its patient tracking information system. Dr. Ralph Kopecky is made head of a task force to identify possible systems that can replace the existing one.

A one-month search unearths two products that are good candidates. Each is an off-the-shelf product that will be modified by the vendor to fit into a client’s existing environment. After lengthy discussions with the vendors, Dr. Kopecky developed the cost and benefit data that appear in the accompanying exhibit. He will employ these data to educate members of the Executive Management Committee about costs and benefits associated with the alternative solutions.

Item	System A	System B
Purchase price	2,300,000	1,600,000
5-year savings compared to using current system	4,100,000	2,700,000
Cost of conversion from old to new system	325,000	300,000
Annual maintenance cost (includes salaries of full-time support personnel)	275,000	200,000

Questions:

1. Using the data contained in the exhibit, compute the benefit-cost ratios associated with adopting System A and System B.

2. Given the data contained in the exhibit, does it make sense from a financial perspective to abandon the current MIS and to adopt a new one? Explain your reasoning.
3. Using the data contained in the exhibit, which solution – System A or System B – is more attractive from a purely financial point of view? Write up your views in a one-page, single-spaced report that will be submitted to the Executive Management Committee.
4. What are the limitations of taking a purely financial approach to selecting a product that will enable Park Crest Hospital to meet its business needs? What other factors should be taken into account?

Answer 1

Ans a)

Benefit Cost Ratio is used to compares benefits and cost from a particular project.

To calculate the BCR, we have to divide total discounted benefits by total discounted costs.

Using the data given above;

1.The cost of adopting System A (2,300,000+325,000+275,000)= 2,900,000

The Benefits that accrue to System A = 4,100,000

Therefore, BCR= 1.41 (4,100,000 /2, 900,000)

2.The cost of System B (1,600,000+300,000+200,000) = 2,100,000

The Benefits that accrue to System B = 2,700,000

Therefore, BCR= 1.29 (2,700,000 /2,100,000)

b)

According to the data given in exhibit the Benefit Cost Ratio of both the systems A and B is more than 1 which means that they generate more benefit than the cost incurred on them. So by the analysis of Benefit Cost ratio we can say that both the systems are efficient and should be consider while taking any decision.

As the amount invested is less and benefit is more it will make sense  from a financial perspective to abandon the current MIS and to adopt the new one.

c)

From a pure financial point of view,

System A is more attractive than System B.

Although both the systems are attractive and can be used instead of the current MIS. But if we compare the Benefit Cost Ratio,System A has higher ratio i.e 1.41 as compared to system B which has ratio of 1.29. Both the ratios are greater than one and less than 2. If the Benefit Cost Ratio is more than 1 it means that project give more benefit than the amount invested in it.

In system B the investment is less in comparison of system A but at the same time the benefit is also less than system A , so it is more efficient for Hospital to use system A.

So it is highly recommended to adopt system A instead of system B as it has greater benefit than cost.

d) The limitations of taking a purely financial approach to selecting a product that will enable Park Crest Hospital to meet its business needs is that while taking decision regarding systems if we consider only one factor and ignore others it may be possible that it will create problems in future.

For an organization the financial aspects are important but it is also important to consider the other factors associated with project because if ignorance is high the chances of project failure is much more.

So while taking decision an organization has to consider all the factors along with financial aspect and then make decision so that it will get benefits from it in future also.

The other factors which are also taken into account along with financial aspects are as follows:

The new system adopted is easy to use and proper training facilities are available for the staff.

The system is adopted after considering the needs of customers so that they were satisfied.

To consider all the risk associated with the new system and try to mitigate it.

The quality of services provided by the new system.