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Running head: GRANT CLINIC, INC: EQUIPMENT PURCHASE AND CAPITAL

Grant Clinic, Inc: Equipment Purchase and Capital Budget Tiffany Mobley, Sabrina Morris, Starla Seward, Tamika Thomas-Carmichael FIN/HC571 June 13, 2011 Mr. Albert White

GRANT CLINIC, INC: EQUIPMENT PURCHASE AND CAPITAL Grant Clinic, Inc: Equipment Purchase and Capital Budget Introduction Investment decisions in fixed assets or capital expenditures are critical and important decisions for a company. Any type of decisions, good or bad could alter the existence of a

company, in this case Grant Clinic. Therefore, evaluating the various methods that are available such as the payback period method, rate of return method, net present value method, and internal rate of return method are critical tools in making financial decisions for Grant Clinic. In order to determine which diagnostic equipment model to purchase, senior management conducted an evaluation of both models using the various financial methods mentioned above. Internal Rate of Return The internal rate of return, IRR, is a discounted cash flow method that takes all incoming and outgoing cash into account over the life of the equipment or project as well as profitability and time value of money (Baker, 2006, p.137) Table A Year 0 1 2 3 4 5 IRR

Model A-120,000 40,000 40,000 Model B -110,000 32,000 32,000

40,000 40,000 40,000 20% 32,000 32,000 32,000 14%

With any project or investment, it is the goal of a business to make a profit and the higher the IRR, the better the investment. Grant Clinic set a 15% target for their rate of return. From the table above, Model A shows a 20% return while model B shows a 14% return. Model A not only meets the clinics target but exceeds their expectations by 5%, showing that Model A will fully cover the cost of the new equipment and provide the clinic with additional income.

GRANT CLINIC, INC: EQUIPMENT PURCHASE AND CAPITAL

The net present value (NPV) is the difference between the PV of the cash inflows and the PV of the cash outflows. If the NPV is a positive it means the investment is more profitable (Finkler, 2007, p. 180). Based on the calculation below Model A would be more profitable for Grant Clinic because it has a positive net present value of $14,120 compared to Model B which has a negative net present value of -$2,704. Model A Year Cash Flow Present Value Factor * Value Factor Total NPV Model B Year Cash Flow Present Value Factor * 0 (120,000 ) N/A (120,000 ) $14,120 0 (110,000 ) 1 40,000 0.870 34,800 2 40,000 0.756 30,240 3 40,000 0.658 26,320 4 40,000 0.572 22,880 5 40,000 0.497 19,880

1 32,000

2 32,000

3 32,000 0.658 21,056

4 32,000 0.572 18,304

5 32,000 0.497 15,904

N/A 0.87 0.756 (110,000 Value Factor ) 27,840 24,192 $ Total NPV (2,704) *Numbers come from Table 8-A-1 pg 194 Chapter 8 Payback Method

The market analyst must calculate the number of years it will take to recover the project's primary investment (Gallagher, 2008). This is completed by adding up the investment cash inflows for a single year at a time until the sum equals the total of the investments primary investment. The amount of years is the payback period. To estimate this method, the analyst must have in mind a meticulous quantity of years that is suitable to the Grant Clinic. If the

GRANT CLINIC, INC: EQUIPMENT PURCHASE AND CAPITAL payback period is less than or equal to that predetermined quantity, then the investment is accepted.

Model A Year Cash Flow Estimated annual labor savings PayBack Period Model B Year Cash Flow Estimated annual labor savings PayBack Method 0 (110,000 ) 32,000 3.4 years 1 110,00 0 32,000 3.4 years 2 110,00 0 32,000 3.4 years 3 110,00 0 32,000 3.4 years 4 110,00 0 32,000 3.4 years 5 110,00 0 32,000 3.4 years 0 (120,000 ) 40,000 3 years 1 120,00 0 40,000 0 3 years 2 120,00 0 40,000 3 years 3 120,00 0 40,000 3 years 4 120,00 0 40,000 3 years 5 120,00 0 40,000 3 years

The choice rule for payback method depends on Grant Clinic's satisfactory payback period. If the projected investment's payback goes beyond the acceptable time limit, then the investment is accepted. Or else, the investment is discarded. The payback method is frequently used when portions such as estimate time threat and liquidity are focused and in addition where uncontaminated profit estimate is used as a solitary criterion. In apply, the highest acceptable payback period is repeatedly chosen as an unchanging value, for example a certain integer of years; lets say five years. Recommendation

GRANT CLINIC, INC: EQUIPMENT PURCHASE AND CAPITAL The departments should review all financial statements, management can make a comparison of one organizations performance according to the industry standard, and create or project the budget for the next fiscal year (Cooper, & Schindler, 2008). It specifies the payback method and total net present value for the collection, measurement, and analysis of data. The budget statement summarizes profitability earned by the Grant Clinic and expenses collected over the years and reveals if Grant Clinic achieved profitability earning an acceptable profit. Second, the statement investors equity shows the changes in the owners capital income over

specific years. The budget sheet is the income statement of financial department and represents a view of the organization as the investor of resources, assets equal to the resources of assets (Ward & Baker, 2006). Finally, the statements of present net value flows show the liquid assets, reflect the cash flows and outflows of cash into and out of an organization, and reveal the cash produced by operating a company (Ward & Baker, 2006). The recent economic downturn and persistent increases in the cost of treatments has contributed to the recent growth in the uninsured, which affects the elements of Grant Clinic being able to afford provide accurate health care to patients.

GRANT CLINIC, INC: EQUIPMENT PURCHASE AND CAPITAL

Pro forma Capital Budget CAPITAL PROJECT BUDGET SUMMARY GRANT CLINIC, INC. Model A Equipment Purchase Labor Savings/year Cumulative Payback: Rate of return NPV IRR Depreciation/year Before taxes Income tax rate 40% After taxes Annual net cash inflow after taxes Model B Cost Labor savings/year Cumulative Payback: Rate of return -110,000 3. 44 years 15% -120,000 -120,000 3 years 15% 14,086 19.86% Year 0 -120,000 Year 1 Year 2 Year 3 Year 4 50,66 7 40,00 0 Year 5

50,667 -80,000

50,667 -40,000

50,667 0

50,667 80,000

24,000 26,667 10,667 16,000 40,000

24,000 26,667 10,667 16,000 40,000

24,000 26,667 10,667 16,000 40,000

24,00 0 26,66 7 10,66 7 16,00 0 40,00 0

24,000 26,667 10,667 16,000 40,000

-110,000 38,667 -78,000 38,667 -46,000 38,667 -14,000 38,66 7 18,00 0 38,667 50,000

GRANT CLINIC, INC: EQUIPMENT PURCHASE AND CAPITAL

NPV IRR Depreciation/year Before taxes Income tax rate 40% After taxes Annual net cash inflow after taxes

-2,731.04 13.95% 22,000 16,667 6,667 10,000 -110,000 32,000 22,000 16,667 6,667 10,000 32,000 22,000 16,667 6,667 10,000 32,000 22,00 0 16,66 7 6,667 10,00 0 32,00 0 22,000 16,667 6,667 10,000 32,000

Discuss Pro Forma Both Model A and Model B have a negative NPV when an annual income tax rate of 40% is figured into the calculations. Because tax payments greatly reduce the amount of cash flow an organization has available, any equipment purchases for a taxable organization should be analyzed on an after-tax basis. If Grant Clinic is a taxable entity and is in desperate need of purchasing one of these pieces of equipment, Model A will be a better investment for the company. However, if Grant Clinic is taxable and they have more time available to research other equipment models, they may find a piece of equipment that is a better return on their investment. Conclusion Any investment decisions, good or bad, can alter the existence of a company. Knowing this, it is crucial for a company to evaluate various financial methods before coming to a decision that could impact the company. In the case of Grant Clinic, Inc., thought the evaluation of three key financial methods as well as the creation of a projected capital budget, the clinic came to the conclusion of purchasing the Model A for their new diagnostic equipment.

GRANT CLINIC, INC: EQUIPMENT PURCHASE AND CAPITAL

References Baker, J. (2006). Health Care Finance: Basic Tools for Non-Financial Managers (2nd ed.). Sudbury, MA: Jones and Bartlett Publishers. Finkler, S. A., Ward, D. M., Baker, J. J. (2007). Essentials of Cost Accounting for Health Care Organizations (3rd ed.). Sudbury, MA: Jones and Bartlett Publishers. Gallagher T. J., & Andrew,.Jr, J. D. (2008). Financial Management (Vol. e, 3rd ed.). Upper Saddle River: Pearson Prentice Hall. Cooper, D.R. & Schindler, P.S. (2008). Business research methods (10th ed). New York: McGraw-Hill/Irwin. pg. 118.