St. Francis Hospital 's Finance Department prepares a consolidated budge t. Additionally, the Hospital's Administrati on Department collects operations data. Exhibit 1 shows the budgets for the past two years (2017 & 2018) , while Exhibit 2 shows an extract of operations data . T he recent downturn in the economy has had a detrimental impact on the Hospital. The CEO asks you to p erform a financial and operations analysis for the Hospital for both years (2017 & 2018) .
Task 2: Cost Allocation and Pricing Analysis
The St. Francis Hospital's Administration Department collects data on many of its services. Data for the Radiology Department, which provides X - ray, MRI an d CT - scan services, are shown on Exhibit 3.
The Finance D epartment is considering two possible cost drivers:
(1 ) Staff hours or (2 ) Number of procedures
1.1 What are the key areas where the Hospital i s having financial difficulties?
1.2 W hy is St. F rancis Hospital losing money?
2.1 Which of the two cost drivers shown above would you recommend as basis for allocating the indirect (overhead) costs? Why? Why is it better than the other?
2.2 Using your recommended cost driver to allocate the indirect ( overhead ) costs, what are the t otal cost of each radiology service ( X - ray, MRI, and CT scan ) ? and what are the c ost per procedure for each radiology service ( X - ray, MRI, and CT scan ) ?
2.3 Compare the price being charged for each procedure to the cost per procedure you have calculated in Item 2.2 . Which procedure(s), if any, is not covering its costs? How much revenue is the Hospital losing because of this?
Task 3: Capital Investments Analysis
St. Francis Hospital is considering several capital investment projects that you must analyze. There are three major investment proposals, as described below. For each of them, the Finance Department evaluates the project over 10 years using a 6% cost of capital. It assumes that cash flow generated or saved accrues only after the completion of the capital investment.
First Proposal: New Microscope Machine
The first proposal involves the purchase of a new state - of - the - art laser - guided microscope for the Neurosurgery Department. GE Medical Devices has quoted a pri ce of $2 million for the
machine, with annual service and maintenance charges equal to 10 percent of the up - front cost. The machine can be installed within 30 days of order and must be paid for immediately. It has an expected life of 10 years.
The Hospita l currently does not perform difficult neurosu rgery (brain tumor and spinal c ord) operations. It believes the advanced capabilities of the new machine will increase the inflow of patients to its Neurosurgery Department, since many local doctors refer patients to the competing Janice Joplin Memorial Hospital . St. Francis Hospital estimates i t will gain an additional 500 neurosurgery patients per year.
The Hospital plans to charge $5,000 for a complex neurosurgery procedure and expects the cost of using the new equipment (including technicians' wages and supplies) to be $3,500 per procedure. However, the Finance Department believes that increasing competition from newer technologies will gradually put increasing pressure on prices. It believes that most p robably the Hospital's price will be cut to $4,000 after five years.
Second Proposal: New Wing for the Orthopedic Department
The second proposal is to construct a new orthopedic wing that will significantly improve the H ospital's ability to provide rehabilitation for orthopedic patients. Construction of the wing will take 12 mo nths and is budgeted to cost $1.6 million . Currently, the Hospital rents space for its Orthopedic Department at an annual cost of $75,000. This will no longer be required once the new wing is complete. Using the Finance Department's standard depreciation schedule, the new building will be worth $800,000 at the end of 10 years.
Third Proposal: New Surgical Center
The third proposal en visions construction of a new surgical center. The new surgical center requires a 2 - year construction period . The new center will immediately open after construction is completed and will provide surgical services 362 days a year. At present the Surgical D epartment performs an average of 1 surgery per day. The new center would double patient throughput. However, there will be an additional cost of $200 per surgery in the n ew center. The Hospital currently receives an average of $1,000 per surgery. The new surgical center will cost $600,000 to construct over a period of two years ($300,000 in each year).
Additionally, after the center is built, the new center will immediately need to lease an equipment at an annual lease payment of $50,000 for five years, at the end of which time the Hospital will own the equipment outright with no further payments due. The Finance Department assumes the useful life of the surgical center and the equipment to be only 10 years, after which it will need to be replaced.
3.1 What is the Net Present Value (NPV) of each project proposal?
3.2 The CEO though thinks that the Third Proposal is riskier than the Finance Department believes. Based on his experience with such projects, he is suspicious of possible cons truction delays or cost overruns. He doesn't feel certain enough to place a
"probability" on individual cash flows, but overall his hunch is that the project might be 50 percent riskier than assumed by the Finance Department. He wants you to recalculate th e Third Proposal 's NPV using 12 % as the cost of capital to account for this additional risk . What is the NPV of the project when the cost of capital is 12%?
3.3 Rank the three projects in order of priority if the only criterion is the net present value of the investment. Which project would you r ecommend and why?
St. Francis Hospital
Budget Versus Actual Statement in $ million
3.5 Medi c
1.4 1.3 Insurance Reimbu r
.8 13.0 10.0 F e
l G r
3.2 3.2 3.2 2
.0 T o
17.9 16. 8
.9 16.8 Expenses
Admin Wages 2.2 2
s S a
1.0 1.0 1.0 1.0
.5 2.5 2 .
6 C o
s fees 2. 5
1.1 1.5 Utilit i
es 0 .
5 0. 5
0.8 Misc. 0.5 1.0 0.5 0 .
5 T o
tal E x
15.6 17.6 O p erating P
rofit/(Loss) 3 .
3 (0.8 )
Ex h ibit 2 St. Francis H
Opera t ing Data
017 2017 2018 2
Budget Actual Budget Actual Nu m
ber o f
patients treated 11,000 16,0 0
2,500 15,500 Number o f
s 49 52 50 52 Day s
of op e
ration 360 361 3
St. Francis Hospital Radiology Department Data
Schedule of Current Charges
X - Ray
Annual Indirect ( Overhead ) Costs
Cleaning and maintenance
Additional Cost Data
Number per Year
Staff Hours per Procedure
X - Ray
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