The Mount Eden Medical Center is considering establishing a screening program for a virulent form of cancer. If the program were established, the center would have to acquire equipment that would cost $8.2 million. Thereafter, the center would incur operating costs of $400,000 per year. The equipment has a useful life of four years. The center estimates that it would screen 3,000 high‐risk patients per year. It calculates that 0.2 percent (six) of these will test positive. With proper treatment, at minimal cost, these patients would be spared the disease. Experts have determined that if they were not screened and as a consequence developed the disease, they would incur at least $300,000 per year in medical costs, for a period of two years, before succumbing to it. The disease would cut short their working lives by an average of 10 years, during which time they would have earned an average of $28,000 per year.
The center uses an interest rate of 10 percent to assess all long‐term projects.
1. What would be the annual net benefits of the program, taking into account the operating costs (excluding the cost of the equipment), the present value of the medical costs, and the present value of lost earnings?
2. Does the present value of the annual net benefits exceed the cost of the equipment? Based exclusively on this criterion, should the program be established? What reservations would you have as to the significance of your analysis?
3. Now assume that the analysis uses a discount rate of 6 percent. Does this change whether the project should be established?
4. Assume that the center has decided to establish the screening program and uses the 10 percent interest rate. However, the screening could be carried out with equal reliability by physician examinations coupled with laboratory tests rather than with the special equipment. The annual cost, however, would be $3 million. Should the center acquire the equipment or carry out the screening with physician examinations and laboratory tests? Base your analysis on a period of four years, the life of the equipment.
Do you have the same reservations about this analysis as you did the previous one?