Case: The X-Ray Machine Mercy Corporation is a for-profit health-care provider that operates three hospitals. One of
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Case: The X-Ray Machine | ||||||||
Mercy Corporation is a for-profit health-care provider that operates three hospitals. One of | ||||||||
these hospitals, Country Health, plans to acquire new x-ray equipment. Management has already | ||||||||
decided the equipment will be cost beneficial and will enhance the technology available in the | ||||||||
outpatient diagnostic laboratory. Before Coutry Health prepares the requisition to corporate | ||||||||
headquarters for the purchase, Brenda Taylor, Country Health's controller, has to prepare an analysis | ||||||||
to compare financing alternatives. | ||||||||
The equipment is a Ultraimage X-ray 2000 machine priced at $1,000,000, including shipping and | ||||||||
installation. The machine will be delivered January 2, 2009. Under the tax regulations, this | ||||||||
machine qualifies as "qualified technological equipment" with a five-year recovery period. It | ||||||||
will be depreciated over five years for tax purposes using double-declining balance for the first | ||||||||
three years and straight line for the final two years. As such, depreciation will be as | ||||||||
follows: 2009 = $400,000; 2010 = $240,000; 2011 = $144,000; 2012 = $108,000; 2013 = $108,000. | ||||||||
The machine will have no taxable salvage value at the end of five years. The three financing | ||||||||
alternatives Country Health is considering are described below. | ||||||||
1. Finance Internally: Country Health would pay the supplier on the day of delivery. | ||||||||
the equipment. The supplier would be paid on the day of delivery. | ||||||||
2. Finance with a Bank Loan: Country Health could obtain a bank loan to finance 90% of the | ||||||||
equipment cost at 10% annual interest, with five annual payments of $237,420 each due at the | ||||||||
end of each year, with the first payment due on December 31, 2009. The loan amortization | ||||||||
schedule is presented below. | ||||||||
Country Health would provide the remaining $100,000, which would be paid on delivery. | ||||||||
Year | Balance | Payment | Interest | Principal Reduction | ||||
1 | $900,000 | $237,420 | $90,000 | $147,420 | ||||
2 | $752,580 | $237,420 | $75,258 | $162,162 | ||||
3 | $590,418 | $237,420 | $59,042 | $178,378 | ||||
4 | $412,040 | $237,420 | $41,204 | $196,216 | ||||
5 | $215,824 | $237,420 | $21,582 | $215,824 | ||||
3. Lease the Equipment: The equipment could be leased from HospLeasing, with an initial payment | ||||||||
of $50,000 due on equipment delivery and five annual payments of $220,000 each, commencing | ||||||||
on December 31, 2009. At the option of the lessee, the equipment can be purchased at the | ||||||||
fair value at lease termination (the lessor is currently estimating a 30 percent salvage value). | ||||||||
The lease satisfies the requirements to be an operating lease for both FASB (Financial Accounting | ||||||||
Standards Board) and income tax purposes. This means that all lease payments are deductible | ||||||||
for tax purposes each year. Because of expected technological changes in medical equipment, | ||||||||
Country Health would not plan to purchase the X-ray equipment at the end of the lease | ||||||||
commitment. | ||||||||
Country Heath has an effective income tax rate of 40%, and an after-tax corporate hurdle rate | ||||||||
of 18%. Income taxes are paid at the end of the year. | ||||||||
Prepare a discounted cash value analysis of the three alternatives. Please note the following: | ||||||||
(a) depreciation is tax deductible, | ||||||||
(b) interest, only, on loan payments is tax deductible, | ||||||||
(c) lease payments, under an operating lease, are completely tax deductible. |
Related Book For
Financial Accounting Information For Decisions
ISBN: 978-0324672701
6th Edition
Authors: Robert w Ingram, Thomas L Albright
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