Question

Community General Hospital

            Community General Hospital has enjoyed a history of success in attracting and maintaining solid patient volumes. Part of their success has been a balanced program of capital equipment purchases to benefit both the care provided to patients and continued new purchases and replacement of equipment.

            The total dollars expend on equipment purchases for the last four years are as follows

2011                           $3,500,000

2012                            4,200,000

2013                            4,050,000

2014                            4,150,000

It is estimated by management that the amount of money to be spent on capital equipment in 2015 will be $ 4,550,000.

A tentative list of requested equipment is presented in Exhibit A. Based on what you have read and studied about capital budgeting:

1. How did the hospital management set the allotted dollars to be spent on capital equipment in this budget year at $ 4,550,000   and

2. What process would be followed and completed in selecting the items to be purchased in the 2015 capital budget?

1. What analysis might be used and how would this work.
2. What discussions would management utilize to make specific equipment purchase decisions?
3. Explain the rationale behind each equipment purchase.

COMMUNITY GENERAL HOSPITAL

EXHIBIT A

Type of Equipment                                                                 Cost

1. Nuclear Medicine Camera                                                 $ 325,000

2. MRI                                                                                    1,500,000

3. Computer System Laboratory                                                285,000

4. Patient Information System                                                    585,000

5. Pharmacy Distribution System                                               387,000

6. Clinical Information System Nursing                                    867,000

7. New Loading Dock – Materials Management                       248,000

8. Air Conditioning – West Wing                                              489,000

9. Hospital Beds - 30                                                                   45,000

10. Echocardiogram Equipment                                                  450,000

11. IV Pumps – 40                                                                         55,000

12. Communications Equipment                                                 355,000

13. Chemical Analyzer – Laboratory                                           988,000

14. Transportation Vans – Food Service                                       75,000

15. Transport Containers – Food Service                                      45,000

16. Information Systems Equipment (Computers)                       278,000

17. Operating Room Tables & Equipment                                   765,000

18. Contingency Spending                                                           350,000

Total                                                                                       $ 8,365,000

Answer 1

Community General Hospital will set the requisite money for replacement of equipments by the following methods:
1. Depreciation on previous equipments is a reserve for future equipment replacement.
2. Creating Asset Specific reserve to be bought later.
3. Raising more finance by debt or equity for buying equipments.

In relation to replacement of existing equipment, capital budgeting requires that,
the NPV of selection buying new asset > NPV of the existing equipment, what it means is that the new equipment will prove more benefits than the existing equipment in the long run.

In case of purchase of new equipment, the benefits of buying new asset should be more than the capital outflow.
The rate of discounting is the Weighted average cost of capital of the hospital for computing the Net Asset Value.

Every asset should be purchased when the Benefits accrued from the purchase of equipments are more than the capital outflow of $4550,000