Portland Cancer Center

Case 18 Leasing Decisions Background The Portland crabmeat pith is a not-for-profit yard bird and outpatient preparedness dedicated to the prevention and treatment of dealcer. Working to perfect noninvasive brain surgery techniques for the past go years, the Center is considering options to replace its received model of the da Gamma poke. Radiosurgery is often referred to as the Gamma prod. The Gamma Knife delivers 201 sepa reckon radiation sources to treat legitimate brain cancers without invasive surgery. For patients with chummy lesions the Gamma Knife significantly reduces the essay associate with traditional running(a) mathematical operations.Other clinical benefits to the Gamma Knife include treating Parkinsons, trigeminal neuralgia, arteriovenous malformations, certain types of benign tumors and small malignant lesions. The Center leave alone open a raw(a) radiation therapy facility for several bare-assed radiosurgery effects. Replacing the Gamma Knife at th is point is scaned as a bridge. This is because the Centers managers think that whether the equipment is purchased or rent it allow be employ for no more than intravenous feeding years sooner moving to the new facility.A financial decision on whether to buy the Gamma knife or direct it is most significant to this case. Facts * Expected physical life of the equipment is ten years * Possibility to writing a cancellation clause and per- effect clause if leased * Possibility the Center will move to new facility sooner than judge * If equipment is to be purchased, appraise-exempt financing could be obtained * GB financing lease involve * Annual allowances of $675,000 * Includes service contract so equipment will be maintained in good working order (GBF will have to enter maintenece contract with manufacturer) GBF forecasts $1. 5 million residual measure out * If lease is not written, GBF could invest the funds in a four year shape loan of similar risk that yields 8% before taxes * The Centers risk is transferred back to lessor * Portland purchasing the Gamma Knife * Invoice price is $3 million, including delivery and installation * Maintenance contract for $100,000/year * Financed by a four-year simple interest conventional margin note at 8% * May claim tax inference for portion of loan payment * Bears all the risk of equipment * correspondence measure is risky. 5% probability after(prenominal) four years will be $500,000 50% probability that it will be $1 million and 25% probability that it will be $2 million. * This risk adds a 5% risk adjustment to the base discount rate used on the other lease-analysis flows epitome This decision is a complex one. Will it be better to use debt financing and purchase or make an investment decision to lease the piece of equipment? It is important to decipher is the lease can save money, eliminate the risk of technological obsolesce, and to share the mutual risk with the lessor.The dollar bell analysis of th e lessees cost of owning and leasing can be seen in Exhibit 1. A 10% discount rate (based on corporate cost of capital) was used to convert the funds flows to present values. The Lessees percentage cost analysis show the internal cost rate (IRR) at 6%. This shows leasing is lower than the corporate cost of capital at 10%. Looking at the lease in terms of per procedure (Exhibit 2), the annual evaluate 100 procedures would cost the Center $25,000 more. Furthermore, if fewer procedures were performed the per-procedure lease would be favored.It could be useful to assess the clinics previous record patterns to determine the risk of this decision. Exhibit 3 shows the Lessors point of view to own the Gamma Knife. Using an opportunity cost rate of 8% before taxes will yield 4. 8% after taxes. The 6. 2% after tax return exceeds the 4. 8% after tax return getable on alternative investments of similar risk. This similarly confirms the NPV of the lease investment is expected to be better o ff by $99,368 if it writes the lease. Recommendations The financial advantage is for Portland Cancer Center to lease the Gamma Knife rather than purchase the equipment.The per procedure lease has a benefit to both parties, however reduces risk for the Center. It would save be advantageous is the volume of procedures was low, specifically below 100 procedures. Maintaining a state of the art healthcare facility is important and the lease will allow the Center to do so. The lessor is compensated for taking risk with tax deductions, however they will assume the risk with the technology. The NAL of $130,554 affirms that leasing creates more value than get in this situation. The lessees IRR of 6% is well below the 10%, which alike indicates a positive aspect to leasing versus buying.The terms of the lease should be conservatively considered, especially the cancellation clause in the contract. This is important to address because of concerns with the new facility being ready before fou r years time. Significant be could be associated with unutilized equipment so GBF could consider adding a penalty to the cancellation clause. The decision is also weighed based upon the move to the new facility. If the Center moves early keeping the equipment and moving it to the new facility is always an option. The Center should also negotiate a lower yearly lease payment.The lease answers the clinics requirement of a short-term commitment with the least risk associated due to a new facility that is on the way. There are also perks to a short- term lease agreement because this is not recorded on the lessees eternal sleep sheet. Exhibit 1 Lessees Analysis bell of Owning stratum 0 form 1 Year 2 Year 3 Year 4 Net purchase price $3,000,000 Maintenance cost 100,000 $100,000 $100,000 $100,000 Maintenence tax nest egg 0 0 0 0 Depreciation tax nest egg 0 0 0 $0 Residual value 1,125,000 Residual value tax 0 Net cash flow $3,100,000 $100,000 $100,000 $100,000 $1,125,000 PV cost of owning $2,223,685 Cost of Leasing remove payment $675,000 $675,000 $675,000 $675,000 Tax nest egg 0 0 0 0 Net cash flow $675,000 $675,000 $675,000 $675,000 $0 PV cost leasing $2,354,239 Cost Comparison Net advantage to leasing (NAL)= $130,554 Lessees Percentage Cost Analysis Leasing-versus-owning CF $2,425,000 $575,000 $575,000 $575,000 $1,125,000 Lessees IRR= 6% Exhibit 2 Per-procedure plight Per Procedure Lease Annual Lease Procedures Annual Annual Annual Annual Lease Net Annual Lease Net Annual Profit hire Revenue Profit Payment Revenue Profit Difference 70 $490,000 $700,000 $210,000 $675,000 $700,000 $25,000 185,000 80 $560,000 $800,000 $240,000 $675,000 $800,000 $125,000 $115,000 90 $630,000 $900,000 $270,000 $675,000 $900,000 $225,000 $45,000 100 $700,000 $1,000,000 $300,000 $675,000 $1,000,000 $325,000 ($25,000) 110 $770,000 $1,100,000 $330,000 $675,000 $1,100,000 $425,000 ($95,000) 120 $840,000 $1,200,000 $360,000 $675,000 $1,200,000 $525,000 ($165,000) 130 $910,000 $1,300,000 $390,000 $675,000 $1,300,000 $625,000 ($235,000) GBF quoted per procedure lease rate of $7,000 *expected annual volume of 100 procedures *expected net revenue per procedure of $10,000 Exhibit 3 Lessors Analysis Cost of Owning Year 0 Year 1 Year 2 Year 3 Year 4 Equipment cost $3,000,000 Maintenance (100,000) ($100,000) ($100,000) ($100,000) Maint tax savings 40,000 40,000 40,000 40,000 Depreciation shield 240,000 384,000 228,000 $144,000 Lease payment 675,000 675,000 675,000 675,000 Tax on payment (270,000) (270,000) (270,000) (270,000) Residual value 1,500,000 Residual value tax (396,000) Net cash flow $2,655,000 $585,000 $729,00 0 $573,000 $1,248,000 NPV $99,368 IRR 6. 20%