You are the newly appointed radiology director of a 300-bed community hospital.

Question

You are the newly appointed radiology director of a 300-bed community hospital. On your first day of duty, your chief radiologist approaches you about the idea of obtaining a new state-of-the-art mammography system costing $300,000.00. The current mammography system is five years old and truly is outmoded. How will you analyze the financial prospects for proceeding with this capital purchase? Be sure to consider payback and net present value in your answer. Your response should be at least 200 words in length.

Explanation / Answer

This is a clear cut capital budgeting problem where management is considering replacing a mammography system. The initial investment in new mammography is expected to be 300,000 which is huge for a health care organization. Since this is a capital budgeting replacement decision, the decision will be based on cash flows and capital budgeting technique. Cash flows would in in the form of improved quality of mammography that will help the organization in charging higher prices for mammography. It can also help them in saving cost of mammography. Therefore, the benefit can be in two forms either improved revenue or cost savings. Thus, annual cash flow would include after tax incremental revenue, after tax cost saving and depreciation tax benefit.

In the first instance, management would be interested in knowing how many years it is going to get the entire investment back (payback period). Lower the payback, better it would be for the firm as it will help them in recovering the investment early. The investment decision would be based on net present value. Net present value is the difference between Present value of annual cash flows and initial investment. The NPV should be greater than 0 to make the project acceptable for the firm.

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