Question

Dollars and Cents versus a Sense of Ethics   

Grizzly Community Hospital in central Wyoming provides health care services to families living within a 200-mile radius. The hospital is extremely well equipped for a relatively small, community facility. However, it does not have renal dialysis equipment for kidney patients. Those patients requiring dialysis must travel as far as 300 miles to receive care.

Several of the staff physicians have proposed that the hospital invest in a renal dialysis center. The minimum cost required for this expansion is $4.5 million. The physicians estimate that the center will generate revenue of $1.15 million per year for approximately 20 years. Incremental costs, including the salaries of professional staff and depreciation, will average $850,000 annually. Grizzly is exempt from paying any income taxes. The only difference between annual net income and net cash flows is caused by depreciation expense. The center is not expected to have any salvage value at the end of 20 years.

The administrators of the hospital strongly oppose the proposal for several reasons: (1) They do not believe that it would generate the hospital’s minimum required return of 12 percent on capital investments; (2) they do not believe that kidney patients would use the facility even if they could avoid traveling several hundred miles to receive treatment elsewhere; (3) they do not feel that the hospital has enough depth in its professional staff to operate a dialysis center; and (4) they are certain that $4.5 million could be put to better use, such as expanding the hospital’s emergency services to include air transport by helicopter.

The issue has resulted in several heated debates between the physicians and the hospital administrators. One physician has even threatened to move out of the area if the dialysis center is not built. Another physician was quoted as saying, “All the administrators are concerned about is the almighty dollar. We are a hospital, not a profit-hungry corporation. It is our ethical responsibility to serve the healthcare needs of central Wyoming’s citizens.”

Instructions

a. Financial factors and measures. (Compute Payback Period, ROI and NPV - Show all calculations for the supporting calculations. ​)

Answer 1

Year	Revenue	Costs including Depreciation	Depreciation	Incremental Operating costs excluding Depreication	Cash flows	PVIF@12%	Net Present Value
0					-4500000	1	-4500000
1	1150000	850000	225000	625000	525000	0.8928571	468750			Payback period is		=	8 Years &	=300000/525000*12
2	1150000	850000	225000	625000	525000	0.7971939	418526.8					=	8 Years &	7	Months
3	1150000	850000	225000	625000	525000	0.7117802	373684.6
4	1150000	850000	225000	625000	525000	0.6355181	333647			Return on Investments		=	525000/4500000%
5	1150000	850000	225000	625000	525000	0.5674269	297899.1						11.67
6	1150000	850000	225000	625000	525000	0.5066311	265981.3
7	1150000	850000	225000	625000	525000	0.4523492	237483.3			Net Present Value		=	-578542
8	1150000	850000	225000	625000	525000	0.4038832	212038.7
9	1150000	850000	225000	625000	525000	0.36061	189320.3			Internal rate of return		=	9.90%
10	1150000	850000	225000	625000	525000	0.3219732	169035.9			(only for your information)
11	1150000	850000	225000	625000	525000	0.2874761	150925
12	1150000	850000	225000	625000	525000	0.2566751	134754.4
13	1150000	850000	225000	625000	525000	0.2291742	120316.4
14	1150000	850000	225000	625000	525000	0.2046198	107425.4
15	1150000	850000	225000	625000	525000	0.1826963	95915.54
16	1150000	850000	225000	625000	525000	0.1631217	85638.87
17	1150000	850000	225000	625000	525000	0.1456443	76463.28
18	1150000	850000	225000	625000	525000	0.1300396	68270.78
19	1150000	850000	225000	625000	525000	0.1161068	60956.06
20	1150000	850000	225000	625000	525000	0.1036668	54425.05
						NPV	-578542