HCM 400 Module 6 Capital Decision Short Paper Example

Replace or Repair? A Capital Decision on Pine Hollow's CT Scanner

[Student Name]

Southern New Hampshire University

HCM 400: Healthcare Finance

Module Six Short Paper

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Replace or Repair? A Capital Decision on Pine Hollow's CT Scanner

Pine Hollow Memorial Hospital's CT scanner was installed eleven years ago. Last year it was out of service an average of nine days a quarter, and on those days patients with suspected strokes or serious injuries had to be transferred forty miles. The vendor will stop supporting the model in two years. The board must decide whether to replace it now, at a cost of $970,000 including installation, or keep repairing it. This paper evaluates the decision using capital budgeting methods.

Why Capital Decisions Need Special Tools

A capital investment involves spending money now to gain benefits over several years. Because a dollar received in the future is worth less than a dollar today, comparing the purchase price with the sum of future savings overstates the value of the investment. Capital budgeting tools, especially net present value, account for the timing of cash flows.

The Cost of Keeping the Old Scanner

Doing nothing is not free. Repair costs for the old scanner rose from $62,000 three years ago to $110,000 last year, and the vendor has warned that some replacement parts will soon be unavailable. Each day of downtime sends emergency patients elsewhere and delays outpatient scans. If the old scanner failed completely before a replacement was arranged, the hospital could lose CT capability for months, with serious consequences for emergency care and for its trauma and stroke transfer agreements. The comparison therefore sets replacement against a baseline that is getting steadily more expensive and less reliable.

Incremental Cash Flows

The analysis counts just the money that moves differently if the scanner is replaced. Four sources of benefit were identified. First, fewer breakdowns would keep about 140 emergency patients a year who are now transferred, each contributing about $350 after variable costs. Second, faster scanning and better image quality are expected to add about 600 outpatient scans a year from local physicians who now refer elsewhere, each contributing about $180. Third, maintenance costs would fall by about $70,000 a year during the two-year warranty and $40,000 afterward. Fourth, because Medicare pays critical access hospitals based on cost, it reimburses its share of the new scanner's depreciation, worth about $50,000 a year.

Annual Estimates

Combining these, net annual cash inflows are estimated at about $215,000 in years one and two and $185,000 in years three through eight, the scanner's expected life, with a $40,000 trade-in value at the end.

Table 1. Estimated Incremental Cash Flows ($ thousands)

Note. Composite estimates; component values rounded, and net figures reflect small offsetting costs.

Payback

Payback measures how long it takes for cumulative cash inflows to recover the investment. After four years, inflows total $215,000 plus $215,000 plus $185,000 plus $185,000, or $800,000. Adding year five's $185,000 brings the total to $985,000, so payback occurs during the fifth year, at about 4.9 years. Payback is simple and useful for a cash-strapped hospital, but it ignores the time value of money and cash flows after the payback point.

Net Present Value

This method discounts each future cash flow back to today using a rate that reflects the hospital's cost of capital, here 6%, then subtracts the investment. The present value of the eight years of inflows and the trade-in is about $1.229 million. Taking away the $970,000 price leaves roughly $259,000 of net present value. A positive value means the investment is expected to return more than the hospital's cost of capital.

Testing the Assumptions

Estimates are uncertain, so the analysis tested alternatives. At a 4% discount rate, the net present value rises to about $361,000; at 8%, it falls to about $168,000. If added outpatient volume is lower, trimming each year's inflow by $40,000, the result shrinks to roughly $11,000, positive but only just. In the base case, the rate that would drive net present value to zero, the internal rate of return, is about 12.5%.

Table 2. Sensitivity of Net Present Value

Note. Composite estimates.

Benefits Not in the Numbers

Some benefits are hard to price. Faster stroke imaging can affect patients' recovery, and fewer transfers spare families long trips. Joynt et al. (2011) found that critical access hospitals had fewer clinical capabilities than other hospitals and higher mortality for some conditions; keeping reliable imaging in the community helps close part of that gap. The scanner also supports physician recruitment, since emergency and primary care physicians want reliable diagnostic tools.

Can the Hospital Afford It?

Kim and McCue (2008) found that nonprofit hospitals' capital investment was associated with their financial strength, including cash flow and profitability, suggesting that weaker hospitals tend to invest less and fall further behind. Pine Hollow faces that trap. Paying cash would reduce days cash on hand from about 48 to about 38, below the 30-day loan covenant cushion the board prefers to keep. Kaufman et al. (2016) found that low liquidity was among the characteristics of rural hospitals that later closed, so protecting cash matters.

Financing Options

Three financing options avoid draining cash. A federal rural community facilities loan could finance the scanner at a low fixed rate over ten years. An equipment lease would spread payments but cost more over time. The hospital foundation could run a community campaign; residents approved the tax levy and have supported equipment drives before. Interest on a loan is also a cost Medicare partly reimburses under cost-based payment.

Recommendation

The scanner should be replaced. Every scenario tested produced a net present value above zero; the purchase pays back within five years and preserves emergency and diagnostic services the community needs. To protect liquidity, the hospital should finance most of the cost through a rural facilities loan and launch a foundation campaign to cover the down payment.

Conclusion

Net present value and payback show that replacing Pine Hollow's CT scanner is financially sound, and the nonfinancial benefits for patients strengthen the case. Financing the purchase rather than paying cash lets the hospital invest without weakening the liquidity that research links to rural hospital survival.

References

Joynt, K. E., Harris, Y., Orav, E. J., & Jha, A. K. (2011). Quality of care and patient outcomes in critical access rural hospitals. JAMA, 306(1), 45-52. https://doi.org/10.1001/jama.2011.902

Kaufman, B. G., Thomas, S. R., Randolph, R. K., Perry, J. R., Thompson, K. W., Holmes, G. M., & Pink, G. H. (2016). The rising rate of rural hospital closures. The Journal of Rural Health, 32(1), 35-43. https://doi.org/10.1111/jrh.12128

Kim, T. H., & McCue, M. J. (2008). Association of market, operational, and financial factors with nonprofit hospitals' capital investment. Inquiry, 45(2), 215-231. https://doi.org/10.5034/inquiryjrnl_45.02.215